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THE  HITCHCOCK  LECTURES 

OF    THE 

UNIVERSITY  OF  CALIFORNIA 
1918 


GEORGE  PILLMORE  SWAIN 


[Reprint  from  "The  Semicentenary  Celebration  of  the  Founding  of  the 
University  of  California   .   .   .     1868-1918."] 


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THE  HITCHCOCK  LECTUEES  OF  THE  UNIVEESITY  OF 
CALIFORNIA,  1918 

GEORGE  FILLMORE  SWAIN,  B.S.,  LL.D. 

Gordon  McKay  Professor  of  Civil  Engineering  in  the  Massachusetts 
Institute  of  Technology,  Harvard  University 

[First  Lecture] 
THE  FIRST  QUEBEC  BRIDGE  AND  ITS  FAILURE 

This  lecture  dealt  with  the  subject  of  the  first  bridge  erected 
across  the  St.  Lawrence  River  just  above  Quebec,  which  failed 
August  29,  1907.  It  was  illustrated  by  many  lantern  slides, 
which  traced  the  history  of  the  structure,  explained  the  type 
adopted  and  its  relations  with  other  types  of  long  span  bridges, 
discussed  the  methods  of  erection  of  bridges,  showed  the  details 
of  the  structure,  and  finally  described  its  failure  and  the  reasons 
for  this. 

This  bridge  as  planned  was  to  have  a  single  span  of  1800  feet, 
the  longest  span  in  the  world.  The  main  structure  was  a  canti- 
lever bridge,  of  three  spans,  located  about  seven  miles  above  the 
City  of  Quebec.  The  largest  span  is  ninety  feet  longer  than  the 
two  spans  of  the  Forth  Bridge,  which  was  completed  in  1889. 

The  piers  of  the  Quebec  Bridge  had  been  completed  and  the 
superstructure  of  the  southerly  half  was  being  erected  by  first 
erecting  the  southerly  shore  arm  on  scaffolding,  and  then  building 
out  the  long  span  piece  by  piece  by  means  of  travellers.  The 
southerly  cantilever  arm  had  been  completed  and  the  suspended 
span  in  the  center  of  the  structure,  which  is  supported  at  each 
end  upon  two  cantilever  arms,  was  being  built  from  the  south- 
erly end.  The  heavy  traveller  at  the  end  of  the  projecting  arm, 
which  had  been  used  in  building  the  southerly  cantilever  army 
had  been  removed,  and  the  central  supported  span  was  being 
built  with  a  lighter  traveller.  A  few  days  before  the  accident 
one  of  the  inspectors  discovered  that  one  of  the  lower  chord 
members  of  the  southerly  anchor  arm  near  the  river  pier  had 
buckled  or  bent  out  of  line  about  two  inches.  A  deflection  at 
this  place  had  been  noticed  the  previous  week,  but  at  that  time 
it  was  only  three-quarters  of  an  inch. 


While  some  of  the  employees  appear  to  have  felt  uneasy  with 
regard  to  this  buckling,  it  was  apparently  considered  by  those  in 
charge  to  be  insignificant  and  not  a  cause  for  anxiety.  On 
August  28th  a  conference  of  the  chief  engineers  and  others  in 
authority  was  held,  and  it  was  decided  to  place  the  situation 
before  the  consulting  engineer  in  New  York.  A  messenger  went 
to  New"  York  for  this  purpose,  and  the  consulting  engineer,  after 
"conference,  telegraphed  Phoenixville,  where  the  bridge  was  being 
fabricated,  and  sent  his  representative  there  for  consultation 
with  the  officers  of  the  bridge  company.  By  the  time  he  arrived 
at  Phoenixville  the  bridge  had  collapsed.  Eighty-five  men  went 
down  with  the  bridge,  and  of  these  only  eleven  were  saved. 

No  such  mass  of  steel  work  had  ever  collapsed  in  the  history 
of  bridge  building.  Some  17,000  tons  of  steel  formed  one  tangled 
mass  of  debris,  extending  from  the  anchor  pier  over  the  central 
pier  down  into  the  main  current  of  the  river. 

A  study  of  engineering  failures  is  more  enlightening  than  a 
study  of  engineering  successes.  The  lecture  discussed  the  causes 
of  the  disaster,  and  drew  the  lessons  which  it  taught. 

The  material  and  workmanship  of  the  bridge  was  considered 
to  have  been  excellent.  The  disaster  was  not  attributed  to  any 
flaw  in  material  or  defect  in  manufacture.  It  was  due  to  the 
failure  of  the  compression  member  and  the  buckling  which  had 
been  noticed.  This  compression  member  had  been  designed 
without  taking  due  account  of  the  actual  weight  of  the  structure, 
the  stresses  in  it  were  allowed  to  be  too  high,  and  the  design  was 
extremely  faulty.  The  lattice  bars  connecting  the  parts  of  the 
member  were  much  smaller  in  strength,  in  proportion  to  the  size 
of  the  piece,  than  those  used  in  ordinary  design.  These  lattice 
bars  had  hitherto  been  designed  in  a  purely  empirical  manner, 
although  it  is  possible  to  apply  to  them  some  principles  of  mechan- 
ics. The  lecturer,  after  the  failure  of  the  bridge  and  after  obtain- 
ing details  of  the  structure,  had  computed  the  strength  of  these 
columns  and  had  found  that  failure  should  have  taken  place 
almost  precisely  when  it  did. 

Facts  and  figures  were  given  with  reference  to  the  details  and 
the  causes  of  the  failure,  which  it  is  not  necessary  to  discuss 
further  in  this  abstract. 


[Second  Lecture]    • 
THE  SECOND  QUEBEC  BRIDGE 

A  strange  fatality  seems  to  have  pursued  this  structure. 
After  the  failure  of  the  first  bridge,  plans  were  made  for  a  new 
one  at  the  same  place  and  with  the  same  span,  although  the 
width  between  trusses  was  greater.  The  design  of  the  new  struc- 
ture was  radically  different  from  that  of  the  old  one,  and  the 
differences  between  the  two  were  explained  and  illustrated  by 
lantern  slides. 

The  new  bridge,  like  the  old,  was  a  cantilever  bridge  of  three 
spans.  The  central  supported  span,  which  rests  on  the  end  of 
the  cantilever  arms,  which  in  the  old  bridge  was  being  built  piece 
by  piece  from  the  cantilever  arm,  was  in  the  new  bridge  designed 
to  be  built  complete  on  the  shore  of  the  river.  When  completely 
erected,  scows  were  to  be  run  beneath  it  and  the  load  transferred 
to  these  scows,  which  were  then  to  be  towed  up  the  river  until 
this  supported  span  was  in  position  between  the  two  ends  of  the 
cantilever  arms,  which  had  previously  been  completely  erected, 
and  the  supported  span  was  then  to  be  raised  by  hydraulic 
machinery  into  its  permanent  position. 

Great  care  had  been  taken  in  the  design  of  the  new  structure, 
and  the  two  cantilevers  had  been  successfully  erected  without 
serious  accident.  The  plans  for  the  supported  span  in  the  center 
and  for  raising  it  into  place  had  also  been  carefully  studied,  and 
were  thought  to  be  beyond  suspicion.  When  the  span  was  being 
raised,  however,  after  it  had  been  raised  a  few  feet  and  the  scows 
had  been  taken  away,  there  was  a  sudden  failure  at  the  southeast 
corner  support,  and  the  entire  supported  span  dropped  into  the 
river. 

The  lecture  explained  by  means  of  numerous  lantern  slides  the 
construction  of  the  bridge,  the  methods  of  erection,  and  the  causes 
for  the  failure.  The  cause  is  considered  by  some  to  have  been  a 
flaw  in  a  steel  casting,  but  it  is  more  probable  that  the  stress  in 
the  casting  was  excessive.  Nevertheless,  the  other  three  castings 
held,  and  it  is  possible  that  there  may  have  been  a  flaw  in  the 


one  that  failed.  The  design  of  these  castings,  however,  was  shown 
to  be  open  to  criticism,  and  the  peculiar  point  was  illustrated  that 
while  more  material  was  put  into  them  than  was  necessary  the 
result  was  a  decrease'  in  strength. 

Following  this  failure  a  new  central  supported  span  was  built, 
and  in  the  following  year  it  was  successfully  erected,  so  that  the 
structure  is  now  complete.  In  the  erection  of  the  final  structure 
the  methods  which  were  considered  open  to  criticism  in  the  pre- 
vious structure  were  changed. 

[Third  Lecture] 

RAPID  TRANSIT  IN  CITIES  AND  THE  MEANS  OF 
OBTAINING  IT 

This  lecture  dealt  with  the  subject  of  the  growth  of  urban 
population,  the  transportation  problems  to  which  this  growth 
had  given  rise,  and  the  methods  of  meeting  these  problems.  The 
lecture  was  illustrated  by  a  large  number  of  lantern  slides  show- 
ing subways  and  elevated  structures  in  various  American  and 
foreign  cities. 

The  two  main  methods  of  providing  rapid  transit  in  cities  are 
by  means  of  subways  and  elevated  lines.  The  first  subway  in  the 
United  States  was  built  in  Boston,  and  the  lecturer  had  been 
connected  as  a  member  of  the  Boston  Transit  Commission  with 
the  construction  of  all  the  Boston  subways  for  the  previous 
twenty-five  years.  The  relative  advantages  and  disadvantages 
of  subways  and  elevated  lines  were  discussed,  the  relative  costs 
compared,  and  the  methods  of  construction  described. 


[Fourth  Lecture] 

THE    PRESENT    SITUATION   WITH   REGARD    TO    THE 

DEVELOMENT  OF  WATER  POWER  AND  FEDERAL 

LEGISLATION  ON  THE  SUBJECT 

There  are  few  points  of  more  practical  interest  to  the  people 
of  this  country  than  the  development  of  water  power.  In  this 
subject  the  people  of  the  Pacific  Coast  should  be  particularly 
interested,  inasmuch  as  they  are  comparatively  remote  from 


deposits  of  coal,  although,  of  course,  they  have  large  supplies  of 
that  other  fuel,  which  has  taken  so  large  a  place  in  industry  in 
recent  years. 

Power  is  one  of  the  great  necessities  of  modern  civilization. 
Indeed  it  may  fairly  be  said  that  this  modern  age  may  be  charac- 
terized more  accurately  than  in  any  other  way  as  an  age  of  the 
development  and  use  of  power.  When  we  remember  that  it  is 
only  one  hundred  and  fifty  years  or  less  since  the  invention  of 
the  steam  engine,  that  the  locomotive  is  not  yet  one  hundred 
years  old,  that  the  telephone,  electric  light,  all  forms  of  electric 
energy,  and  practically  all  of  our  modern  machinery  have  been 
developed  within  one  hundred  and  fifty  years,  prior  to  which 
time  almost  all  manufacturing  was  done  by  hand,  is  it  not  clear 
that  this  is  an  age  primarily  of  power  and  machinery? 

The  sources  of  power  are  two,  viz. :  the  combustion  of  fuel, 
and  the  harnessing  of  the  natural  power  developed  by  falling 
water.  These  two  sources  are  fundamentally  different  in  their 
economic  significance.  Every  pound  of  fuel  that  is  burned  is 
permanently  lost  to  mankind  and  can  never  be  recovered.  Con- 
servation of  fuel  means  economy  and  restriction  in  its  use.  Seeing 
that  the  end  of  our  fuel  supplies  must  come  at  some  time,  perhaps 
in  the  not  very  distant  future,  it  is  essential  that  the  greatest 
possible  economy  should  be  exercised  in  its  use.  The  power  of 
falling  water,  on  the  other  hand,  is  generated  constantly  by  our 
rivers  as  they  flow  from  their  sources  to  the  sea,  and  only  needs 
to  be  harnessed  in  order  to  be  utilized.  Every  pound  of  falling 
water  not  harnessed  or  used  is  lost  forever  and  can  never  be 
recovered,  although  providentially  the  power  goes  on  perpetually 
from  year  to  year,  renewing  itself  constantly. 

Conservation  of  fuel,  therefore.,  means  the  greatest  possible 
restriction  in  its  use :  conservation  of  water  power  means  the 
greatest  possible  extension  of  its  use.  Every  horse  power  devel- 
oped by  water  not  only  provides  that  power  for  use,  but  elim- 
inates development  of  power  by  means  of  combustion  and  per- 
manent loss  of  fuel.  Conservation  of  water  power  is  therefore 
a  double  conservation ;  it  saves  not  only  the  power  itself,  which 
otherwise  runs  to  waste,  but  it  prevents  or  replaces  the  develop- 
ment of  power  by  the  use  of  something  which  once  used  can  never 
be  replaced. 


There  is  a  third  element  involved,  which  makes  the  use  of 
water  power  a  triple  conservation.  Much  has  been  said  in  recent 
years  with  reference  to  the  desirability  of  improving  our  means 
of  inland  navigation  by  making  our  rivers  navigable.  In  general 
this  can  only  be  done  by  means  of  locks,  dams,  and  canals,  by 
which  a  river  is  converted  into  a  series  of  pools,  or  reaches,  in 
which  the  velocity  and  depth  are  sufficient  for  navigation.  Most 
projects  for  inland  navigation  are,  in  the  opinion  of  the  speaker, 
uneconomical  and  undesirable.  Transportation  by  river  and 
canal  has  been  outgrown  and  superseded  by  transportation  by 
rail,  except  in  certain  special  localities,  as,  for  instance,  on  the 
Great  Lakes  and  wherever  long  distances  can  be  traversed  by 
water  by  means  of  large  vessels.  If  anyone  doubts  this  he  has 
only  to  read  Professor  Moulton's  interesting  book  entitled 
"Waterways  vs.  Railways,"  or  Mr.  John  Howe  Peyton's  book 
on  railroad  transportation  in  order  to  be  convinced.  Nevertheless, 
much  is  said  about  inland  navigation,  and  in  some  cases  and  for 
small  craft  it  is  a  desirable  means  of  transportation.  The  point 
now  to  be  observed  is  that  the  development  of-  water  power  by 
the  building  of  a  dam  is  a  large  step  in  making  a  river  navigable. 
The  dam  should,  of  course,  be  located  not  solely  with  reference 
to  the  requirements  of  water  power  but  also  with  reference  to 
the  requirements  of  navigation.  If  so  located,  a  water  power 
development  is  a  navigation  improvement.  Conservation  of  water 
power,  therefore,  not  only  develops  power  and  prevents  it  going 
to  waste,  but  also  conserves  fuel  and  navigation,  and  is,  therefore, 
a  triple  conservation.  At  the  present  moment  with  the  enormous 
demand  for  fuel,  its  price  is  very  high,  and  the  supply  is  in- 
sufficient for  daily  requirements.  In  the  East  there  has  been  a 
coal  famine  this  winter,  the  seriousness  of  which  is  propably  not 
appreciated  by  those  who  live  in  the  warm  climate  of  California. 
Many  people  have  been  unable  to  get  coal  enough  to  keep  them- 
•  selves  decently  or  comfortably  warm  through  a  winter  of  un- 
exampled severity.  The  coal  supply  has  been  doled  out  in  baskets- 
ful  or  bagsful  under  the  direction  of  public  committees,  and  our 
coal  yards  have  every  day  been  crowded  with  anxious  people 
trying  to  get  a  few  pounds  to  keep  themselves  warm.  An  ex- 
mayor  of  the  city  in  which  I  live,  finding  himself  out  of  coal  and 
trying  to  get  some  was  told  by  his  dealer  that  the  best  he  could 


do  was  to  let  him  have  one  ton  if  he  would  send  and  get  it. 
Some  people  have  had  to  close  up  their  houses  and  live  in  hotels. 
Factories  have  been  obliged  to  restrict  output  at  the  very  time 
when  it  should  have  been  increased  to  its  maximum.  Even  in 
Philadelphia,  close  to  the  coal  deposits  of  Pennsylvania,  there 
has  been  much  suffering  and  distress. 

The  situation  indicates  forcibly  the  need,  in  the  interests  of 
the  public  and  of  the  nation,  of  the  greatest  possible  or  practic- 
able development  of  water  power,  for  water  power  can  be  used 
not  only  for  power  but  for  heat  and  light.  Moreover,  the  intro- 
duction of  electrical  transmission  of  power  has  made  it  possible 
to  develop  water  power  in  Inaccessible  regions,  where  such  power 
exists,  and  to  transmit  it  for  use  up  to  a  distance  of  over  two 
hundred  miles  with  very  little  loss  in  transmission.  Previous  to 
the  development  of  electrical  transmission  water  power  was  under 
the  great  handicap  that  it  could  only  be  used  at  or  near  the  point 
of  development  which  is  frequently  in  remote,  mountainous,  or 
otherwise  inaccessible  regions.  Electrical  transmission  has,  there- 
fore, revolutionized  the  status  of  water  power  and  enormously 
increased  its  importance.  With  the  development  of  electrical 
transmission  has  also  come  the  increasing  use  of  electricity  as  a 
means  of  utilizing  power.  Electric  light  has  become  the  almost 
universal  illuminant  and  electric  motors  are  universally  used  to 
drive  our  street  cars  and  largely  used  to  drive  machinery  in  mills. 
One  of  the  great  developments  in  the  future  will  be  its  increased 
use  in  operating  our  railroads  by  means  of  electric  locomotives 
instead  of  steam  locomotives.  Electric  powder  is  also  used  in 
many  commercial  processes,  such  as  the  manufacture  of  nitrogen- 
ous products  for  explosives  and  fertilizers,  and  in  other  processes 
requiring  the  production  of  a  high  temperature. 

In  view  of  all  the  foregoing,  it  seems  passing  strange  that 
water  power  has  not  been  utilized  to  a  greater  extent.  It  would 
seem  self-evident  that  the  interests  of  the  public  would  require 
its  greatest  possible  economic  development.  Notwithstanding  this 
its  development  has  lagged  behind  that  of  steam.  The  last  census 
of  the  United  States  in  1909  showed  the  total  owned  steam  and 
gas  power  in  use  in  forty-three  leading  industries  to  be  14,950,525 
horse  power,  and  the  total  water  power  in  use  1,822,888  horse 


10 

power.  Mr.  Leighton,  formerly  Hydrographer  of  the  United 
States  Geological  Survey,  states  that  the  developed  water  power, 
according  to  the  census  made  in  1908  is  5,356,680  horse  power. 
Mr.  Leighton  estimates  that  the  undeveloped  water  power 
amounts  to  37,000,000  horse  power  for  twenty-four  hours  a  day 
and  365  days  in  the  year,  of  which  one-third  is  in  the  northern 
Pacific  region.  Another  government  estimate  is  28,000,000  horse 
power.  But  the  greater  part  of  the  undeveloped  power  is  at  sites 
where  at  the  present  time  there  is  no  market.  Mr.  Leighton 
further  states  that  in  his  opinion  "The  available  water  power 
sites  in  the  country  are  all  developed."  It  should  be  remarked, 
however,  that  the  electrification  of  our  railroads  would  make 
available  a  great  many  sites  where  otherwise  there  would  be  no 
market.  Moreover,  many  sites  now  developed  might  have  the 
power  much  increased  if  provision  were  made  for  proper  storage 
which  would  supply  water  during  dry  seasons.  The  increase  in 
power  available  by  this  means  is  very  great,  the  absolute  maxi- 
mum power  possible  by  development  in  this  country  amounting 
in  Mr.  Leighton 's  opinion,  to  "a  conservative  total  of  at  least 
200,000,000  horse  power." 

There  is  no  question  in  the  minds  of  those  who  have  given 
this  problem  careful  consideration  that  there  is  in  this  country 
an  immense  supply  of  water  power  possible  of  commercial  de- 
velopment if  a  market  could  be  established,  and  that  the  electri- 
fication of  railways  and  the  development  of  electro-chemical 
industries  may  offer  a  market  for  much  of  this  power.  A  large 
part  of  the  power  within  range  of  commercial  development  is  in 
the  region  of  the  Columbia  River  and  the  northwestern  Pacific 
slope.  It  is  stated  by  good  authority  that  "The  largest  amount 
of  water  power  in  any  one  state  is  contained  in  the  state  of 
Washington,  which  has  nearly  10,000,000  water  horse  power,  of 
which  less  than  three  per  cent  has  been  developed.  In  Washing- 
ton coal  is  mined  and  steam  power  plants  are  operated  within 
the  range  of  the  sound  of  descending  waters,  and  trainloads  of 
coal  are  imported  each  day  from  British  Columbia."  The  same 
authority  gives  a  list  of  actual  projects  for  the  development  of 
water  power  in  navigable  streams  which  have  been  held  back 
from  development,  amounting  to  2,122,000  horse  power.  At  all 
events  a  very  great  amount  of  power  is  possible  of  development 


11 

as  an  engineering  proposition,  and  in  view  of  the  fuel  shortage 
its  development  and  use  should  be  carefully  studied  and  encour- 
aged in  every  reasonable  way. 

This  subject  has  within  the  last  three  months  been  taken  up 
by  the  Chamber  of  Commerce  of  the  United  States  through  a 
committee  appointed  for  the  purpose,  and  a  referendum  has  been 
issued  to  constituent  members  throughout  the  country  briefly 
discussing  the  subject  and  asking  for  a  vote  on  certain  funda- 
mental principles  involved. 

In  a  recent  consular  report  on  the  chemical  industries  of 
Norway  the  following  statement  is  made : 

In  surveying  the  chemical  industries  of  Norway  there  are  several 
features  worthy  of  careful  study  by  the  American  economist.  First 
and  foremost  is  the  systematic  and  exhaustive  manner  in  which  the 
abundant  water  power  of  the  country  is  now  being  regulated, 
stored  up,  and  pressed  into  the  service  of  the  steadily  increasing 
group  of  the  electro-chemical  industries.  The  best  talent  of  the 
nation  is  enlisted  in  this  cause  and  the  way  is  rapidly  being  opened 
for  Norway  to  assume  an  industrial  position  commensurate  with 
its  size  and  admirable  facilities  for  maritime  transportation. 

Why  should  not  the  United  States  devote  equal  attention  to 
the  development  of  its  great  resources  ? 

From  the  above  figures  and  other  available  statements  and 
estimates  it  seems  probable  that  there  is  today  in  use  between 
four  and  five  times  as  much  steam  power  as  water  power,  and 
that  there  is  still  undeveloped  water  power  which  could  be 
practically  developed  amounting  to  much  more  than  all  of  the 
steam  power  now  in  use. 

The  development  of  water  power  besides  saving  fuel  and 
affording  a  means  of  improving  navigation,  would  bring  other 
important  advantages.  It  would  release  for  other  service  the 
labor  of  millions  of  men  employed  in  mining,  transportation, 
and  distribution;  it  would  release  hundreds  of  thousands  of 
freight  cars  now  used  in  transporting  coal,  as  well  as  thousands 
of  locomotives;  it  would  save  much  damage  and  inconvenience 
due  to  smoke  and  soot,  and  thereby  tend  to  improve  human  health 
and  cleanliness. 

Every  horse  power  than  can  be  developed  by  water  and  used 
to  replace  steam  power  saves  in  the  neighborhood  of  $15  worth 
of  coal  per  annum.  If  this  saving  is  capitalized  at  ten  per  cent 
it  .justifies  an  investment  of  say  $150  a  horse  power  in  a  water 


12 

power  plant  in  excess  of  a  steam  plant.  If  10,000,000  horse  power 
could  be  developed  by  water  this  justifies  an  investment  of 
$1,500,000,000.  There  seems  little  doubt  that  at  least  5,000,000 
horse  power  could  today  be  developed  by  water  if  encouragement 
were  offered.  This  would  mean  an  annual  saving  of,  say, 
$75,000,000  in  cost  of  coal  alone. 

Mr.  Hugh  L.  Cooper  estimates  that  the  utilization  of  35,000,000 
horse  power  by  water  power  would  save,  as  compared  with  steam 
power,  the  sum  of  $1,241,600,000  per  annum,  besides  conserving 
280,000,000  tons  of  coal  and  transferring  to  other  needs  the 
service  of  600,000  railway  cars,  20,000  locomotives,  and  740,000 
laborers. 

Why  then  has  water  power  not  been  more  developed  ?  There 
are  two  reasons;  first,  the  high  cost  of  development  of  water 
power  and  its  inferiority  to  steam  in  most  respects;  second, 
governmental  restriction  and  discouragement.  Let  us  consider 
these  two  in  some  detail. 

1.  High  Cost  of  Development  of  Water  Power  and  Its 
Inferiority  to  Steam  in  Most  Respects 

One  of  the  fundamental  mistakes  in  the  popular  conception 
of  water  power  is  that  it  is  cheap.  The  power  itself  is  observed 
running  to  waste  and  it  is  inferred  that  as  the  power  is  there  and 
does  not  require  to  be  developed  but  only  to  be  harnessed,  it  can 
be  utilized  at  small  expense.  Such  a  view  is  incorrect. 

No  power  plant  would  be  built,  whether  for  steam  or  water, 
except  in  the  expectation  that  it  would  be  profitable  for  its 
owners,  that  is  to  say,  that  the  gross  return  would  be  sufficient 
to  cover  all  charges  and  leave  a  net  return  of  an  amount  sufficient 
to  be  attractive. 

With  reference  to  the  cost  of  power  the  charges  to  be  deducted 
from  gross  earnings  are  five,  viz. :  fuel,  other  operating  expenses, 
taxes,  depreciation,  and  fixed  charges.  A  water  power  plant  has 
the  advantage  that  there  will  be  no  charge  for  fuel,  and  that 
other  operating  expenses  will  be  small.  The  taxes  and  depreciation 
will  be  perhaps  the  same  in  either  case,  though  vthe  depreciation 
should  be  smaller,  in  general,  for  a  water  power  plant.  The  fixed 
charges,  however,  will  be  very  much  greater  for  the  water  power 


13 

plant.  It  is  not  generally  realized  that  the  initial  cost  of  a  water 
power  plant  will  generally  be  from  two  to  five  times  as  much 
per  horse  power  as  for  a  steam  plant,  and,  furthermore,  that  the 
initial  development  will  have  to  provide  for  a  larger  total  horse 
power.  This  arises  from  the  fact  that  the  construction  necessary 
for  a  water  power  plant  frequently,  or  generally,  involves  a  dam, 
which  may  be  of  great  size,  and  a  very  large  area  of  land  which 
must  be  flooded,  and  riparian  rights  acquired,  together  with 
canals,  pen  stocks,  flumes,  or  conduits,  and  sometimes  of  great 
length,  as  well  as  transmission  lines  many  miles  in  length,  all 
of  which  is  in  addition  to  the  power  house  itself  with  its 
necessary  machinery.  A  steam  plant  is  simple,  involving  simply 
the  buildings  and  land  for  them,  with  the  necessary  machinery. 
The  risk  to  the  investor  on  account  of  the  greater  initial  cost  and 
higher  fixed  charges  is,  therefore,  much  greater  for  the  water 
power  plant  than  for  the  steam  plant.  Moreover,  in  case  of 
failure  there  is  a  greater  salvage  in  the  steam  plant.  The  land 
and  buildings  may  be  abandoned  and  used  for  other  purposes, 
for  they  are  generally  located  near  the  point  of  utilization  or 
in  a  city,  whereas  a  water  power  plant,  like  a  railroad,  can  only 
be  used  for  the  purpose  for  which  it  was  designed  and  cannot 
be  abandoned  and  given  up  to  some  other  use.  The  investor  in 
a  water  power  plant  must,  therefore,  be  prepared  to  face  fixed 
charges  of  from  two  to  five  times  that  of  a  steam  plant  per  horse 
power;  and  this  of  itself  would  be  sufficient  to  deter  investors 
from  entering  this  field  unless  favorable  conditions  should  exist 
both  as  to  development  and  utilization  and  freedom  from  undue 
interference  by  public  authorities.  Furthermore,  as  already 
stated,  the  initial  development  in  a  water  power  plant  must  be 
greater  relatively  than  in  a  steam  plant.  Most  undertakings 
grow  from  small  beginnings.  If  steam  power  is  used,  a  small 
power  plant  may  be  built  first,  with  one  boiler  and  one  engine. 
If  the  undertaking  is  successful  and  the  demand  for  power  grows, 
it  is  easy  to  add  more  units.  In  a  water  power  plant,  on  the 
other  hand,  the  dam,  reservoirs,  tunnels  and  other  conduits,  must 
be  planned  for  a  greater  capacity  than  will  be  available  at  the 
beginning,  for  it  may  be  difficult,  if  not  impossible,  to  increase 
the  capacity.  The  turbine  wheels,  of  course,  may  be  increased 


14 


in  number  as  the  demand  for  power  increases,  but  the  other 
elements,  except  the  transmission  line,  are  not  so  easily  increased. 
This  element  then  also  increases  the  initial  investment  and  the 
risk  to  the  investor.  There  is  still  another  advantage  in  a  steam 
plant,  arising  from  the  relatively  greater  possibility  of  improve- 
ment in  the  efficiency  of  steam  machinery.  A  water  wheel  will 
utilize  eighty  or  more  per  cent  of  the  theoretical  energy  of  the 
falling  water,  and  the  loss  in  electrical  transmission  will  be  small. 
There  is,  therefore,  only  a  possibility  of  a  slight  increase  in 
efficiency  due  to  improvements  in  the  art,  probably  not  over  five 
to  ten  per  cent.  On  the  other  hand,  in  a  steam  plant  the  best 
reciprocating  engines  or  steam  turbines  develop  but  little  more 
than  fifteen  per  cent  of  the  theoretical  energy  of  the  coal  and 
the  best  gas  engines  something  over  twenty  per  cent.  It  is  evi- 
dent that  the  margin  for  possible  increase  in  efficiency  is  very 
great.  As  a  matter  of  fact,  notwithstanding  the  increase  in  the 
cost  of  fuel,  both  the  initial  cost  and  the  operating  cost  of  steam 
plants  has  decreased  considerably  within  recent  years.  Not  many 
years  ago  a  steam  plant  was  commonly  estimated  to  cost  in  the 
neighborhood  of  $100  per  horse  power,  while  recently  (before  the 
war,  of  course)  large  plants  have  been  built  at  an  initial  cost  of 
$40  or  $50  per  horse  power,  and  these  plants  are  said  to  have 
generated  power  for  about  three  and  a-third  mills  per  kilowatt 
hour  exclusive  of  interest  and  depreciation,  which  means  for  con- 
stant power  twenty-four  hours  a  day  and  365  days  in  the  year 
about  $22  per  horse  power.  If  to  this  we  add  twelve  per  cent,  on 
$40,  for  interest  and  depreciation  on  the  initial  cost,  we  arrive  at 
a  total  cost  under  $27  per  horse  power  per  annum  under  favorable 
conditions,  but  varying,  of  course,  very  greatly,  depending  upon 
the  manner  in  which  the  power  is  used,  whether  constantly  or 
only  during  the  day,  the  cost  of  fuel  and  labor,  whether  steam 
is  needed  and  used  for  other  purposes,  as  for  heating,  processes 
of  manufacturing,  etc. 

Moreover,  steam  power  is  constant  from  day  to  day  through- 
out the  year,  while  water  power  fluctuates,  sometimes  very 
greatly.  At  periods  of  low  water  there  may  be  very  little  power, 
while  at  other  times  there  may  be  a  disastrous  flood.  The  works 
are  liable  to  damage,  and  if  the  power  to  be  developed  is  to  be 


15 

greater  than  the  absolute  minimum  flow  of  the  stream  it  must  be 
by  storage,  which  can  only  be  procured  by  means  of  reservoirs, 
involving  the  taking  and  flooding  of  large  areas. 

Water  power  can  be  produced  aside  from  fixed  charges  at  a 
lower  cost  than  steam  power,  if  the  conditions  are  favorable, 
owing  to  the  absence  of  cost  for  fuel  and  the  lower  cost  for  labor ; 
but  the  fixed  charges  on  the  much  larger  investment  often  suffices 
to  bring  the  total  cost  above  that  for  steam  power. 

Summing  up,  the  large  initial  cost  of  water  power  develop- 
ments and  the  greater  risk  to  the  investor,  together  with  the 
greater  proportional  development  required  at  the  beginning,  is 
the  main  deterrent  under  this  first  heading  to  water  power  de- 
velopment. Once  safely  financed  and  in  operation,  with  a  good 
market,  and  fair  treatment,  water  power  developments  are  very 
attractive  on  account  of  the  greater  convenience,  the  small  operat- 
ing expense,  the  small  amount  of  labor  employed,  and  the  conse- 
quent absence  of  labor  troubles,  the  independence  of  fuel  supply, 
the  smaller  depreciation  (in  general),  and  the  comparatively 
small  amount  of  working  capital  needed.  These  advantages, 
however,  may  be  more  than  offset  if  burdensome  regulations  and 
restrictions  are  likely  to  be  imposed  by  public  authority. 

It  is  a  common  impression  that  water  powers  are  very  profit- 
able undertakings,  which  are  being  sought  by  capital  as  a  means 
of  securing  large  returns  on  a  small  investment.  Such  is  not  the 
case.  It  has  been  pointed  out  that  the  investment  is  large  and 
that  in  many  respects  steam  power  offers  greater  possibilities 
for  profit  than  water  power.  If  water  power  is  to  be  developed, 
the  conditions  must  be  made  favorable,  and  inducements  must 
be  offered  to  investors,  including  reasonable  assurance  of  fair 
treatment  from  the  public  authorities.  Present  demand  for  the 
development  of  water  power — and  there  is  a  large  demand  in 
many  localities — generally  comes  not  from  capitalists  who  are 
seeking  for  profitable  investment,  but  more  often  from  communi- 
ties and  industries  which,  on  account  of  the  high  price  and 
scarcity  of  fuel,  are  desirous  in  their  own  interest  of  inducing 
capital  to  make  such  developments;  just  as  the  demand  for  the 
building  of  railroads  in  the  early  days  arose  quite  as  much,  if 
not  more,  from  the  desire  of  communities  and  states  to  secure 


16 

transportation  facilities  in  order  to  develop  the  public  resources 
as  it  did  from  investors  who  saw  the  possibilities  of  large  returns. 

The  collateral  advantages  resulting  from  the  development  of 
water  power,  viz.,  the  saving  in  fuel,  in  labor,  in  transportation, 
the  absence  of  smoke  and  soot,  are  reaped  not  by  the  owners  of 
the  water  power  but  by  the  community  as  a  whole.  If  the  total 
water  power  in  the  country  now  commercially  capable  of  develop- 
ment could  be  brought  into  use,  there  is  no  question  that  the  total 
direct  and  indirect  saving  to  the  public  in  the  conservation  of 
fuel  and  the  release  of  labor  and  railroad  equipment,  as  well  as 
in  other  ways,  would  run  into  hundreds  of  millions  of  dollars 
annually,  perhaps  billions  of  dollars. 

The  above  considerations  show  the  importance  of  approaching 
the  subject  with  an  attitude  of  mind  which  recognizes  that  the 
development  of  water  power  is  of  benefit  mainly  to  the  com- 
munity as  a  whole,  and  that  in  order  to  secure  such  benefits 
water  power  developments  must  be  made  attractive  to  capital, 
rather  than  with  the  attitude  of  mind  which  assumes  that  such 
enterprises  should  be  surrounded  with  as  many  restrictions  as 
possible.  Particularly  is  this  the  case  at  this  moment  in  this 
country.  Capital  will  have  abundant  opportunities  after  this 
war,  both  here  and  abroad.  States,  communities,  and  individ- 
uals will  be  clamoring  for  it,  and  it  will  be  comparatively  scarce, 
owing  to  the  great  destruction  of  wealth  which  has  taken  place. 
There  will  also  be  a  scarcity  of  labor  unless  the  labor  supply  of 
Oriental  countries,  which  have  not  felt  the  devastation  of  war, 
can  be  utilized,  which  seems  to  many  desirable  though  it  may  not 
appeal  to  some  of  you  on  the  Pacific  Coast. 

This  leads  us  to  consider  the  second  reason  why  water  power 
has  not  been  more  extensively  developed,  viz., 

2.  Governmental  Restriction. 

It  is  self-evident  that  large  water  powers  will  generally  exist 
on  large  streams  on  which  navigation  is  possible  and  which  come 
within  the  category  of  navigable  streams,  or  else  in  regions  near 
head  water  which  may  lie  within  the  public  lands  of  the  Forest 
Reserve.  It  is  stated  on  good  authority  that  of  77.2  per  cent  of 
the  water  power  resources  of  the  country  which  require  a  Federal 


17 

permit,  less  than  4  per  cent  has  been  developed,  while  of  22  per 
cent  of  those  resources  which  do  not  require  a  Federal  permit 
25  per  cent  has  been  developed.  (This,  of  course,  may  be  partly 
due  to  inaccessibility,  lack  of  market,  etc.)  As  a  matter  of  fact 
many  undeveloped  water  powers  are  in  whole  or  in  part  under 
control  of  the  Federal  Government,  either  because  they  are  on 
navigable  streams  or  require  the  use  of  public  lands.  With 
respect  to  these  powers  the  policy  of  the  Federal  Government  in 
recent  years  has  been  such  that  their  development,  instead  of 
being  encouraged,  has  been  almost  prohibited.  I  will  endeavor 
to  briefly  summarize  the  situation. 

Federal  Acts  prior  to  1899  had  prohibited  the  building  of 
dams  in  navigable  rivers  in  such  manner  as  to  obstruct  or  hinder 
navigation  or  in  places  where  they  might  interfere  with  actual 
navigation  until  the  plans  for  such  works  should  be  approved  by 
the  Secretary  of  War.  In  1899  an  act  was  passed  requiring  the 
consent  of  Congress  for  the  building  of  such  structures  and  the 
approval  of  the  plans  by  the  Chief  of  Engineers  and  the  Secre- 
tary of  War.  Since  the  passage  of  this  act  it  has  been  customary 
to  obtain  a  special  act  of  Congress  for  the  development  of  each 
water  power  on  navigable  streams.  These  acts  generally  require 
very  properly  that  any  changes  which  may  be  rendered  necessary 
if  the  structure  is  found  to  obstruct  navigation  in  the  future 
shall  be  carried  out  by  the  owners  at  their  own  expense. 

In  1906  the  so-called  General  Dam  Act  was  passed,  in  which 
further  restrictions  were  added,  requiring  the  permittee  to  con- 
struct, maintain,  and  operate  at  his  own  expense  such  locks  or 
other  structures  or  appliances  which  the  Secretary  of  War  at 
any  time  might  deem  necessary  in  the  interests  of  navigation,  and 
that  if  Congress  should  authorize  the  construction  of  a  lock  for 
navigation  in  connection  with  a  dam,  the  owner  should  convey 
to  the  United  States,  free  of  cost,  the  title  to  such  land  as  might 
be  required,  and  should  operate  such  locks,  and  maintain  such 
lights  and  signals,  at  his  own  expense,  as  the  Secretary  of  Com- 
merce and  Labor  should  prescribe.  These  conditions  were  not 
obligatory,  but  they  might  be  imposed  by  the  Secretary  of  War 
at  his  option,  although  another  section  of  the  act  allowed  the 
United  States  to  construct  and  maintain  locks  or  other  struc- 


18 

tures  required  for  navigation  at  its  own  expense.  The  main 
objection  to  the  act,  however,  was  that  it  was  revocable  by  the 
Government  at  any  time.  In  1910  the  act  of  1906  was  amended 
and  still  further  restrictions  added,  providing  for  the  collection 
of  a  charge  for  any  head-water  improvements  made  by  the 
United  States  which  might  improve  the  flow  of  the  stream,  even 
though  the  permittee  did  not  profit  by  them.  Any  act  was  made 
revocable  at  any  time,  but,  if  revoked,  the  United  States  was  to 
pay  the  owners  the  reasonable  value  of  the  works,  as  decided  by 
the  court  if  not  by  agreement.  Permits  were  to  be  given  for  a 
period  not  exceeding  fifty  years.  This  last  act  was,  therefore, 
more  fair  to  the  permittee  than  that  of  1906,  because  it  provided 
that  if  the  rights  should  be  revoked  the  owner  should  receive 
compensation.  It  did  not,  however,  provide  for  any  compen- 
sation at  the  end  of  the  period  of  the  lease,  which  could  not  be 
greater  than  fifty  years,  nor  for  any  renewal  at  that  time.  The 
owner,  therefore,  who  developed  the  water  power  would  have  to 
amortize  or  receive  back  his  entire  capital  during  the  fifty  year 
period. 

It  will  be  observed  that  by  this  last  act  the  permit  was  re- 
vocable at  any  time :  if  revoked  the  United  States  was  to  pay  com- 
pensation, and  had  a  term  not  to  exceed  fifty  years,  without 
compensation  or  renewal  at  the  end  of  that  period ;  also  that  the 
permittee  might  be  required  to  give  land  for  locks  and  to  con- 
struct and  operate  such  locks  at  his  own  expense.  Notwithstand- 
ing the  fact  that  by  constructing  the  dam  he  made  a  large  con- 
tribution toward  rendering  the  stream  navigable,  he  was  required, 
or  might  be  required  to  contribute  still  more.  There  was  no 
question  as  to  the  propriety  of  his  paying  for  any  benefit  which 
he  might  receive  from  head-water  improvements,  if  he  actually 
received  it.  The  government  also  reserved  the  right  to  alter  and 
amend  the  act  at  any  time.  Any  riparian  owner  building  a  dam 
for  power  purposes,  therefore,  placed  himself  entirely  at  the 
mercy  of  the  Federal  Government.  But  even  these  restrictions 
were  not  sufficient  for  those  entirely  well-meaning  and  enthusi- 
astic persons  who  maintained  that  the  government  should  not 
give  away  any  of  its  rights  on  navigable  streams  or  on  the  public 
domain,  but  who  failed  to  perceive  the  importance  of  encourag- 


19 

ing  water  power  development.  They  maintained  that,  in  addi- 
tion, the  permittee  should  be  charged  for  the  power  developed. 
They  insisted  on  the  imposition  of  such  charge,  together  with  the 
other  burdens  referred  to,  being  placed  upon  riparian  owners  who 
desired  to  utilize  their  natural  riparian  rights  and  incidentally 
to  confer  a  considerable  benefit  upon  the  government  without 
expense  to  it  by  improving  the  navigability  of  the  stream.  Sev- 
eral bills  providing  for  the  construction  of  dams  across  navigable 
streams  were  vetoed  in  1908,  1909,  and  1912,  because  they  con- 
tained no  provision  for  compensation,  or  because  the  act  of  1906 
did  not  terminate  the  permit  at  some  fixed  time.  There  was 
great  difference  of  opinion  in  Congress  regarding  these  matters, 
and  in  general  it  may  be  said  that  Congress  was  in  favor  of 
greater  liberality  toward  permittees,  while  the  executives  believed 
in  restriction.  In  1913  a  bill  to  permit  the  construction  of  a 
dam  for  water  power  purposes  across  the  Connecticut  River, 
which  provided  for  compensation  to  the  government,  to  which  the 
applicants  for  the  privilege  had  agreed,  was  defeated  in  Congress 
by  the  votes  of  those  who  were  willing  to  give  the  company  the 
privilege  without  compensation  but  were  unwilling  to  establish 
the  precedent  or  to  recognize  the  principle  that  the  government 
is  entitled  to  receive  it.  They  believed  that  while  it  had  the 
power,  it  had  not  the  legal  or  moral  right  to  accept  it. 

Prior  to  January  30,  1912,  the  Federal  Government  expended 
at  the  Des  Moines  Eapids  on  the  Mississippi  Eiver  the  sum  of 
$1,458,103  for  inadequate  navigation  facilities,  and  prior  to 
June  30,  1912,  the  sum  of  $12,184,987  for  navigation  improve- 
ments on  the  entire  stretch  of  the  river  between  the  mouth  of 
the  Missouri  and  St.  Paul.  Since  1910  the  Mississippi  River 
Power  Company  as  a  private  investment  has  expended  upward 
of  $20,000,000  at  the  Des  Moines  Rapids,  and  has  constructed  a 
magnificent  dam  with  locks  of  deep  draft. 

On  the  Coosa  River  in  Alabama,  which  is  navigable  in  its 
upper  and  its  lower  portions,  but  not  in  an  intermediate  distance 
of  about  one  hundred  miles,  in  which  improvements  by  the  gov- 
ernment have  been  considered  impracticable  on  account  of  the 
expense,  navigation  improvements  had  cost  prior  to  1876  about 
$1,500,000.  Under  an  act  of  1907  a  water  power  dam  has  been 


20 

constructed  without  expense  to  the  government  at  a  cost  of  over 
$2,000,000,  and  in  1912  a  similar  improvement  was  proposed  at 
another  place  at  nearly  the  same  cost.  This  was  vetoed  because 
no  compensation  was  provided.  In  this  case  the  applicants  pro- 
posed to  build  a  nitrate  plant,  producing  a  product  valuable  for 
fertilizers  or  explosives.  If  this  bill  had  not  been  vetoed,  this 
country  would  have  had  a  nitrate  plant  today.  As  it  was,  when 
the  permit  was  refused  the  applicants  went  to  Canada  and 
located  their  plant  there. 

Similar  restrictions  have  been  urged  upon  the  government 
and  adopted  with  reference  to  the  development  of  water  power 
on  the  public  domain.  Here  it  is,  of  course,  proper  that  if  gov- 
ernment lands  are  used  the  permittee  should  either  pay  for  them 
outright  or  pay  a  reasonable  annual  charge.  Where,  however, 
the  public  domain  is  only  incidentally  affected,  as,  for  instance, 
where  some  portion  of  it  would  be  flooded  by  the  pond  created 
by  the  dam,  or  where  government  land  is  crossed  by  flumes  or 
transmission  lines,  if  water  power  development  is  to  be  encour- 
aged it  is  desirable  that  the  permittee  should  acquire  a  permanent 
right  or  that,  at  all  events,  he  should  not  be  subjected  to  any 
onerous  restrictions.  This  case,  however,  according  to  present 
regulations  is  treated  just  the  same  as  the  case  where  the  govern- 
ment owns  the  site  of  the  power  itself.  The  main  obstacle  to 
development  in  these  cases  does  not  arise  from  the  rates  which 
are  charged,  which  are  generally  reasonable,  but  from  the  form 
and  condition  of  the  permit,  which  at  present  is  revocable  at  any 
time  at  the  will  of  the  government  department  by  which  it  is 
granted,  and  also  subject  to  other  deterrent  restrictions.  Can 
you  imagine  that  investors  will  knowingly  put  their  money  into 
water  power  developments  if  the  fact  that  a  small  part  of  the 
transmission  line  which  may  lie  upon  government  lands  subjects 
the  entire  development  to  the  charge  of  instant  revocation  of  its 
rights  upon  the  whim  of  a  cabinet  officer?  As  a  matter  of  fact, 
on  March  2,  1909,  the  Secretary  of  Agriculture  and  the  Secretary 
of  the  Interior  did  revoke  some  twenty-five  permits,  substituting 
permits  with  different  conditions.  It  may  be  that  the  revocations 
in  this  case  were  not  made  for  the  purpose  of  embarrassing  the 
permittee,  but  were  to  meet  altered  conditions;  but  the  fact 


21 

remains  that  permits  could  be  revoked  and  have  been  revoked  at 
the  pleasure  of  a  cabinet  officer,  and  that  the  revocations  made  did 
embarrass  the  permittee. 

Among  the  other  provisions  with  reference  to  water  powers  on 
the  public  lands  which  hinder  the  development  of  power  are  the 
following :  If  the  government  takes  the  property,  the  price  paid 
is  to  be  fixed  by  the  government  or  by  a  member  of  the  cabinet. 
It  is  sometimes  provided  that  a  company  operating  under  a  gov- 
ernment permit  shall  not  sell  more  than  fifty  per  cent  of  its 
power,  or  some  other  percentage,  to  any  one  concern.  How  could 
railroad  electrification  be  promoted  under  such  restrictions? 
Rental  rates,  which,  as  we  have  stated  above,  are  properly  im- 
posed, may  be  revoked  by  the  Secretary  and  new  ones  imposed  at 
periods  of  not  less  than  ten  years.  In  imposing  new  rates,  appre- 
ciation in  land  values  is  considered  as  income  in  estimating  a 
fair  return  to  the  investor,  who,  of  course,  never  receives  this 
appreciation,  since  the  land  is  used  and  necessary  for  the  works. 
Notwithstanding  this,  in  case  the  property  is  taken  by  the  United 
States  or  by  state  or  municipal  corporations  only  the  original 
cost  of  the  tangible  property  is  to  be  paid  to  the  owner.  He  is 
here  not  to  be  allowed  the  appreciation  of  land. 

The  inadequacy  of  the  present  laws  to  encourage  water  power 
development  has  been  recognized  by  several  cabinet  members 
directly  concerned,  who  have  referred  to  them  as  "absolutely 
inadequate  and  thoroughly  unsound  in  principle  and  practice." 
Please  remember,  then,  that  the  present  defects  of  water  power 
legislation  may  be  summed  as  follows,  as  outlined  in  the  report 
of  the  committee  of  the  Chamber  of  Commerce  of  the  United 
States : 

Water  Powers  on  the  Public  Domain 

As  to  water  powers  on  the  public  domain  (lands  the  title  to 
which  is  in  the  United  States), — a  permit  has  to  be  obtained  from 
the  Department  of  Agriculture  or  the  Department  of  the  Interior, 
whichever  has  control  over  the  site  in  question,  and,  no  matter  how 
much  the  investment  required,  the  permittee  must  accept  a  permit 
which  is  upon  the  face  and  in  fact,  arbitrarily  revocable  at  any 
time, — that  is,  revocable  by  the  same  department  that  grants  the 
permit.  His  permit  also  may  be  made  subject  to  any  conditions 
which  the  department  may  see  fit  to  impose  at  the  time  the  permit 
is  granted.  But  this  is  not  all,  for  his  permit  is  made  subject  to 
any  further  condition  which  the  same  department  may  at  any  time 
choose  to  impose,  adding  further  burdens  or  restrictions  even  after 


22 


his  investment  has  been  made.  Indeed,  if  a  homesteader  happens 
to  make  entry  upon  the  land  covered  by  the  site  occupied  by  the 
investor's  water-power  plant,  then  immediately  the  permit  is,  by 
virtue  of  such  entry,  automatically  revoked.  And  in  neither  case  is 
the  investor  protected  by  provision  for  compensation.  His  entire 
investment  is  at  the  hazard  of  loss  or  confiscation  from  the  moment 
it  is  made. 

Again,  even  if  the  water-power  site  is  located  outside  of  the 
public  domain  and  it  becomes  necessary  to  use  or  cross  any  part  of 
tne  public  domain  for  a  transmission  line  or  otherwise,  then,  no 
matter  how  slight  the  use,  a  permit  must  be  gotten  for  such  use, 
and  the  same  hazard  of  revocation  prevails  as  in  the  case  of  a 
permit  for  a  public  domain  site. 

The  result  is  that,  out  of  about  5,000,000  kilowatts  of  energy 
commercially  feasible  to  be  developed  from  the  water  powers  upon 
the  public  domain,  only  about  one-tenth  have  been  developed. 
4,500,000  kilowatts  of  energy  on  the  public  domain  are  unneces- 
sarily and  unreasonably  allowed  to  continue  to  waste,  because  the 
legislative  restrictions  and  hazards  prevent  the  necessary  invest- 
ment of  private  capital. 

Water  Powers  on  Navigable  Streams  Outside  the  Public  Domain 

Under  the  present  status  (Acts  of  1906  and  1910)  applying  to 
water  powers  outside  the  public  domain,  the  term  of  the  permit 
cannot  exceed  fifty  years,  and  at  the  end  of  that  time  the  permittee 
has  no  rights  whatever.  No  consideration  is  taken  of  the  length  of 
time  required  to  build  up  his  business  and  to  get  on  a  profit-paying 
basis,  nor  of  the  necessary  investment  to  keep  his  plant  up-to-date. 
At  the  end  of  the  50-year  term,  or  a  shorter  term  if  it  were  made 
shorter,  he  must  lose  his  entire  investment.  To  save  himself  from 
this  loss  he  must  amortize  his  plant,  which  is  impossible;  that  is, 
he  must  add  to  his  charges  for  service  such  amounts,  beyond  the 
otherwise  ordinary  charges  necessary  to  bring  a  fair  profit,  as  are 
sufficient  to  pay  him  back  by  the  end  of  his  term  his  entire  invest- 
ment. Tn  many  instances  this  would  make  his  charges  beyond  the 
rate  which  would  bring  a  demand  for  his  service. 

But  this  is  not  his  only  hazard.  His  permit  may  be  arbitrarily 
revoked  at  any  time  before  the  end  of  his  term,  and  that,  too, 
without  compensating  him  adequately  for  his  investment.  More- 
over, arbitrary  conditions  at  the  will  of  the  War  Department  may 
be  imposed,  and  the  nature  and  extent  of  the  burdens  or  hazards 
which  may  thus  be  arbitrarily  imposed  are  left  indefinite  and  un- 
certain. Furthermore,  he  is  subject  to  such  conditions  not  only 
imposed  at  the  time  and  as  a  part  of  his  permit,  but  it  is  also 
subject  to  other  indefinite  and  uncertain  conditions  and  burdens 
which  may  be  imposed  subsequently  thereto. 

This  makes  it  impossible  for  any  investor,  acting  under  such  a 
consent  of  the  Congress  and  a  permit  issued  thereunder,  to  com- 
pute with  any  business-like  approximation  the  amount  of  the  invest- 
ment which  he  may  ultimately  be  compelled  to  make.  Of  course, 
where  the  investment-cost  per  horse  power  produced  exceeds  a  fixed 
sum,  varying  under  various  conditions,  the  enterprise  is  not  com- 
mercially feasible;  that  is,  development  and  operation  mean  a  loss 
of  profit  and  a  loss  of  investment.  These  water-power  developments 
require  large  capital  and  careful  financing,  all  of  which  is  impos- 
sible in  the  face  of  these  uncertainties  and  hazards  before  which 
capital  necessarily  shrinks.  There  have  been  developments  on 


navigable  streams  within  the  past  few  years,  but  none  of  these  has 
been  made  under  any  permit  granted  under  act  of  Congress  since 
1907.  These  developments  are  under  consents  granted  under  prior 
acts. 

These  are  the  reasons  for  the  present  stagnation  of  water-power 
development  on  navigable  streams  in  this  country.  The  legislative 
defects  now  existing  are  apparent  and  not  denied  by  any  sane 
student  of  the  subject. 

The  present  administration  appears  to  recognize  the  difficulty 
and  is  endeavoring  to  deal  with  it.  The  Committee  of  the 
Chamber  of  Commerce  of  the  United  States,  as  above  stated,  has 
prepared  a  referendum.  This  committee  has  made  the  following 
recommendations : 

1.  As  to  all  developments,  whether  within  or  outside  the  public 
domain,   a  separate  act  of  Congress  should  not  as  at  present  be 
required  for  each  development;  but  the  authority  to  issue  permits 
should  be  vested  in  some  department  or  commission  designated  for 
that  purpose  and  under  conditions  protective  of  the  interest  of  the 
public  and  of  tne  investor. 

The  advisability  of  this  action  has  been  generally  recognized 
by  most  students  of  the  question. 

2.  Permits  should  be  issued  for  a  period  of  at  least  50  years, 
unless  at  the  option  of  the  applicant  a  shorter  period  is  agreed  upon, 
and  should  be  irrevocable,  except  for  cause. 

It  will  not  be  sufficient  to  fix  the  term  of  a  permit  as  "not 
exceeding  50  years. ' '  This  would  allow  the  government  authority 
to  dictate  a  shorter  period.  Capital  investments  in  water  power 
development  should  be  allowed  at  least  a  50-year  period  in  order 
to  insure  a  reasonable  average  annual  return,  making  up  in  later 
years  for  losses  incurred  throughout  the  period  necessary  to 
build  up  the  business.  A  50-year  period  is  recognized  very 
generally  among  financiers  as  the  shortest  reasonable  period  for 
such  an  investment. 

3.  A  toll  should  be  imposed  by  the  government  only  on  power 
developments  on  the  public  domain  or  benefited  by  head-water  im- 
provements maintained  by  the  government.     Such  tolls  should  be 
based  upon  the  horse  power  actually  developed,  used,  and  sold.    The 
tolls  should  be  reasonable,  and  proportionate  to  the  benefits  actually 
derived. 

A  distinction  is  not  always  recognized,  as  it  should  be,  between 
tolls  exacted  for  permits  for  sites  on  the  public  domain  and  those 
exacted  under  permits  to  develop  power  on  navigable  streams 
outside  the  public  domain.  Tolls,  as  such,  exacted  for  the  pur- 
pose of  revenue,  are  not  justifiable  in  reason  or,  according  to 


LM 

good  authorities,  in  law  when  imposed  under  permits  for  the 
improvement  of  navigable  streams  outside  the  public  domain. 

The  government  owns  the  public  domain  and  when  it  grants 
a  permit  for  a  site  on  the  public  domain  it  may  reasonably  exact 
a  toll,  but  a  permit  for  a  development  upon  a  navigable  stream 
not  on  the  public  domain  is  simply  a  permit  to  improve  rfparian 
rights  owned  by  the  applicant,  and  the  sole  justification  for  even 
requiring  a  permit  in  such  a  case  is  to  protect  the  paramount 
right  of  the  government  to  regulate  and  protect  navigation.  On 
such  streams,  therefore,  a  toll,  if  exacted  at  all,  should  be  simply 
in  the  nature  of  a  license  fee  to  cover  the  cost  to  the  government 
of  such  control  and  inspection  of  construction  and  operation  as 
are  necessary  to  protect  the  interests  of  navigation. 

In  case  the  government  makes  improvements  at  the  head- 
waters of  the  stream,  which  improve  its  flow,  and  is,  therefore, 
beneficial  to  water  powers  below,  it  is  proper  that  the  amount  of 
such  actual  benefit  received  should  be  paid  back,  in  part  at  least, 
by  all  the  users  of  water  power,  in  order  to  reimburse  the  govern- 
ment to  some  extent  for  the  operation  of  the  headwater  improve- 
ment. It  is  to  be  observed,  however,  that  navigation  interests 
benefit  by  such  headwater  improvements  equally  with  water 
powers  and  perhaps  more  so,  and  that  this  benefit  is  given  without 
•charge  to  those  who  profit  from  the  navigation  facilities,  for  the 
federal  policy  regarding  navigation  is  stated  by  the  act  of  Febru- 
ary 27,  1911,  as  follows : 

No  tolls  or  operating  charges  whatever  shall  be  levied  upon  or 
collected  from  any  vessel,  barge,  or  other  water  craft,  passing 
through  any  lock,  canal,  canalized  river,  or  other  work  for  the  use 
or  benefit  of  navigation  now  belonging  to  the  United  States  or 
which  may  be  hereafter  acquired  or  constructed. 

It  is  difficult  to  see  why,  in  view  of  this  provision,  any  toll,  even 
for  headwater  improvements,  should  be  levied  upon  users  of  water 
power;  for  it  discriminates  against  them  in  comparison  with 
navigation  interests,  while,  as  a  matter  of  fact,  the  development 
of  water  power  is  much  more  beneficial  to  the  public  and  ought 
to  be  much  more  encouraged  than  the  development  of  inland 
navigation. 

Any  toll  levied  for  headwater  improvements  should  be  accur- 
ately defined.  If  stated  as  so  much  "horse  power  per  annum" 


25 

it  is  uncertain  whether  it  is  to  be  based  on  the  number  of  potential 
horse  power  possible  of  development  at  the  site,  whether  or  not 
developed,  utilized,  or  sold ;  or  whether  on  the  basis  of  the  actual 
horse  power  generated  at  the  site  as  a  matter  of  fact,  without 
reference  to  the  quantity  utilized;  or  again,  whether  upon  the 
power  actually  developed,  used  and  sold.  The  latter  basis  alone 
should  be  the  proper  basis  of  the  toll.  The  owner  of  the  site 
might  have  at  his  disposal  already  much  more  than  he  could  find 
a  market  for,  and  any  headwater  improvements  might  simply 
result  in  a  greater  flow  of  water  over  his  dam,  without  benefit 
to  him.  Why,  then,  should  he  be  taxed  for  such  headwater  im- 
provements, which  he  has  not  asked  for,  does  not  desire,  and 
cannot  use? 

4.  If  public  lands  form  only  a  small  and  incidental  part  of  the 
entire  development,  the  licensee  should  be  entitled  to  acquire  the 
right  to  use  such  lands,  paying  the  government  fair  and  just  com- 
pensation for  such  use. 

One  of  the  greatest  obstacles  to  development  of  water  power 
on  the  public  domain  in  cases  where  it  is  necessary  for  a  trans- 
mission line  or  pipe  line  to  cross  a  small  portion  of  government 
land,  but  in  which  the  site  of  the  power  itself  is  not  on  the 
public  domain,  is  the  impossibility  of  obtaining  any  assurance 
from  the  government  that  he  can  get  the  necessary  rights,  under 
any  reasonable  tenure,  which  will  assure  him  of  security  in  his 
investment.  Any  such  slight  use  of  government  lands  which  may 
be  necessary  to  his  enterprise  may  under  present  regulations 
result  in  arbitrary  revocation  of  his  entire  permit,  and  may, 
therefore,  mean  the  destruction  of  his  entire  investment. 

5.  At  the  expiration  of  the  license  period  the  government  should 
have  the  right  to  recapture  the  property  for  itself  or  for  a  new 
licensee  upon  the  payment  of  fair  and  just  compensation  for  the 
property    and   for    all    dependent   property,    if   taken;    and    if   the 
dependent  property  is  not  taken,  then  fair  and  just  compensation 
should  be  paid  for  all  severance  damages. 

Provision    should    be    made    that,    all    things    being    equal,    the 
original  licensee  have  priority  over  any  new  licensee. 

No  great  development  of  water  will  take  place  unless  the 
rights  of  permittees  at  the  expiration  of  the  permit  are  properly 
protected.  It  seems  clear  that  the  government  should  have  the 
power  to  recapture  the  property  at  that  time  by  paying  for  it  its 
fair  value  at  that  time.  It  should  not  have  the  power  to  take  a 


26 

portion  of  the  entire  property,  leaving  to  the  owner  a  portion 
which  is  vitally  dependent  upon  the  portion  taken  by  the  govern- 
ment, unless  fair  compensation  is  paid  for  the  damage  thereby 
sustained. 

6.  At  the  expiration  of  the  license  period  the  government  should 
1^1)   agree  with  the  licensee  as  to  the  terms  of  a  new  license,   (2) 
recapture  for  itself  or  for  a  new  licensee,  or  (3)  continue  the  license 
under  the  original  terms. 

If  the  government  does  not  desire  to  take  over  the  property 
at  the  expiration  of  the  license  it  is  clear  that  it  should  be  obliged 
either  to  continue  the  license  under  the  original  terms  or  agree 
upon  new  terms  with  the  old  licensee.  It  should  not  have  the 
power  to  force  the  old  licensee  to  accept  its  own  terms. 

7.  Rates  and  services  should  be  regulated  by  state  commissions 
where  the  service  is  intrastate,  and  only  by  federal  authority  where 

'the  service  is  interstate  and  the  commissions  of  the  states  which  are 
directly  concerned  do  not  agree  or  there  is  no  state  commission. 

The  exercise  of  any  federal  jurisdiction   over  the  issuance  of 
securities  would  be  unnecessary  and  unwise. 

8.  No    preference    should    be    allowed    as    between    applicants, 
whether  a  municipality  or  otherwise,  which  amounts  to  the  granting 
at  the  expense  of  the  government  of  a  subsidy  creating-  unequal 
competition  in  the  same  market. 

Some  bills  relating  to  this  subject  have  proposed  that  muni- 
cipalities or  states  should  be  granted  permits  without  charge  while 
private  parties  must  pay  a  toll.  This  would  make  it  possible 
after  a  private  company  had  developed  a  power  and  was  selling 
it,  for  instance,  for  electric  lighting  purposes,  for  the  muni- 
cipality to  develop  another  power  and  enter  into  competition 
with  the  existing  company,  not  only  for  municipal  purposes  but 
for  private  purposes,  which  might  result  in  the  ruin  of  the 
original  company.  It  should  not  be  possible  for  such  a  condition 
to  arise.  It  would  mean  putting  into  the  market  a  competitor 
subsidized  at  the  expense  of  the  government.  It  would  mean 
that  a  private  licensee  would  under  a  government  license  expend 
time  and  money  to  build  up  a  market  and  business  and  when^ 
perhaps  after  a  long  period,  the  time  for  making  profits  began 
then  the  government  would  under  another  license  give  to  a 
municipal  corporation,  free  of  cost,  other  power  with  which,  as 
a  competitor,  to  enter  into  a  market  already  built  up  under 
burdens  of  expense  imposed  by  the  government.  There  would  bo 


27 

competitors  in  the  same  market,  the  one  under  the  burden  of 
expenditure  imposed  by  the  government  permits,  licenses  or 
leases,  and  the  other  subsidized  either  by  a  remission  of  capital 
expenses  or  of  tolls  and,  therefore  receiving  free  of  cost  the 
benefits  of  improvements  paid  for  by  the  government. 

In  view  of  the  benefits  to  the  community  which  are  brought 
about  by  the  development  of  water  power,  it  is  earnestly  to  be 
hoped  that  action  will  soon  be  taken  by  Congress  which,  instead 
of  restricting,  will  encourage  to  the  greatest  possible  extent  the 
investment  of  capital  in  these  enterprises.  Without  any  interest 
in  any  of  them  and  looking  at  the  subject  purely  as  a  student 
of  public  policy,  the  speaker  has  become  convinced,  especially  in 
view  of  the  developments  during  this  war,  that  it  will  be  better 
for  the  Federal  Government  to  pay  a  subsidy  to  encourage  the 
development  of  water  power  and  to  remove  all  restrictions  so  far 
as  possible,  always  reserving  to  the  government  the  power  to 
take  over  the  property  at  any  time  in  the  future  at  its  fair  value 
at  such  time.  Perhaps  when  that  time  comes  the  courts  will  have 
finally  decided  what  fair  value  is,  and  how  it  is  to  be  determined. 


[Fifth  Lecture] 

SOME  CONTROVERSIAL  POINTS  IN  THE  VALUATION 
OF  PUBLIC  UTILITY  PROPERTIES 

The  subject  of  the  valuation  of  public  utilities  and  other  prop- 
erties has  come  prominently  into  the  public  eye  within  two  or 
three  decades.  It  has  led  almost  to  the  formation  of  a  new  branch 
of  engineering,  and  has  attracted  the  attention  of  many  economists 
and  publicists. 

The  problem  of  estimating  the  value  of  an  industrial  property 
is  of  course  old.  Bankers  and  business  men  have  for  many  years 
been  obliged  to  attack  it  in  order  to  form  an  opinion  which  would 
justify  purchase  or  sale,  or  the  flotation  of  new  securities,  par- 
ticularly since  the  era  of  industrial  combination  set  in.  But  the 
great  increase  in  interest  in  the  subject  has  been  mainly  the 
result  of  the  increasing  regulation  of  public  utilities  by  state  and 
national  regulating  commissions.  When  it  was  decided  that 


28 

public  authorities  could  fix  the  rates  to  be  charged  by  public 
utility  corporations,  the  question  naturally  arose  at  the  outset, 
upon  what  sum  should  the  company  be  allowed  to  earn  at  least 
a  fair  return  ?  "When  it  became  necessary  for  a  public  board  to 
decide  upon  new  issues  of  capital,  or  upon  the  proper  total  capital 
to  be  allowed  the  company  or  upon  the  price  to  be  paid  for  a 
taking,  the  question  naturally  arose,  what  is  the  fair  value  of  the 
property  represented?  When  it  became  necessary  to  allow  a 
company  to  earn  a  certain  depreciation  allowance,  it  was  natur- 
ally at  once  queried,  upon  what  value  shall  such  allowance  be 
reckoned  ? 

However,  it  is  easy  to  go  too  far  in  the  application  of  any 
theory.  There  is  clearly  no  relation  between  any  particular 
railroad  rate,  as,  for  instance,  that  between  San  Francisco  and 
Chicago,  and  the  value  of  the  property.  The  rate  between  com- 
petitive points  must  be  the  same  by  all  roads,  independent  of 
value.  The  most  that  can  be  said  of  railroad  rates  is  that  if  the 
earnings  as  a  whole,  over  a  large  district,  are  not  sufficient  to 
give  a  fair  return  on  the  total  value  of  the  property,  they  should 
be  increased,  and  vice  versa.  Yet  even  here,  some  roads,  by 
virtue  of  low  cost  of  construction  or  exceptional  efficiency  of 
management,  may  prosper  on  the  old  rates,  while  other  roads 
may  become  bankrupt.  The  limits  for  the  use  of  a  valuation  at 
all  is  a  subject  for  careful  consideration.  We  are  in  danger  of 
forgetting  that,  in  the  words  of  Jefferson,  "That  country  is  best 
governed  which  is  least  governed."  May  it  not  be  that  we  are 
regulating  too  much,  and  forgetting  that  after  all,  the  principle 
that  rates  should  be  determined  by  what  the  traffic  will  bear, 
rightly  applied,  is  perhaps  the  best?  At  all  events,  this  principle 
has  been  the  one  under  which  our  railroad  system  has  mainly 
developed,  and  it  has  developed  business  and  given  us  lower  rates 
and  better  service  than  in  any  other  country  on  earth. 

It  is  very  generally  assumed  that  the  courts  have  decided  that 
a  railroad  company,  or  any  public  utility  company,  shall  earn  no 
more  than  a  fair  return  upon  its  property.  This,  however,  is  not 
my  understanding  of  the  situation.  I  do  not  understand  that  the 
Supreme  Court  has  ever  established  that  doctrine.  The  function 
of  that  Court  is  only  to  decide  whether  any  action  violates  the 


29 

Constitution  of  the  United  States,  and  in  rate  cases  to  decide  when 
a  rate  is  so  low  as  to  result  in  confiscation  of  private  property. 
In  exercising  this  function  I  understand  that  it  has  decided  that 
one  criterion  by  which  to  decide  whether  rates  fixed  by  legislative 
authority  are  so  low  as  to  deprive  a  railroad  company  of  its 
property  without  just  compensation,  according  to  the  Constitu- 
tion, is  that  if  those  rates  prevent  the  company  from  earning  less 
than  a  fair  return  upon  the  present  value  of  the  property  used 
in  the  service  of  the  public,  then  those  rates  are  too  low  and 
violate  the  Constitution.  It  has  never  decided  that  rates  must  be 
fixed  at  such  a  point  that  only  a  fair  return  will  be  earned,  and 
it  is  easy  to  see  that  there  may  be  other  elements  entering  into 
the  problem.  A  railroad  company  experiences  years  of  depres- 
sion, during  which  earnings  are  less  than  normal.  In  order  to 
earn  a  fair  return  on  the  average  it  must,  therefore,  earn  more 
than  a  fair  return  in  good  years  to  balance  the  years  in  which  it 
will  earn  less,  under  any  rate  schedule;  and,  furthermore,  it 
must  be  allowed  to  earn  a  surplus,  to  provide  for  unforseen  con- 
tingencies, such  as  floods,  earthquakes,  etc.  Rates  cannot  be 
suddenly  changed,  as  in  the  case  of  an  industrial  property,  to 
conform  to  varying  conditions.  A  certain  degree  of  flexibility 
of  rates,  giving  the  opportunity  to  meet  emergencies,  now  often 
impossible  under  our  regulating  system,  is  much  to  be  desired, 
but,  in  general,  rates  should  be  stable.  The  basis  of  a  fair  return 
upon  the  present  value  of  the  property  used  in  the  service  of  the 
public  seems,  therefore,  clearly  to  indicate  only  the  minimum 
return. 

The  Supreme  Court,  however,  has  distinctly  said  that  if  the 
rates  charged  by  a  public  utility  corporation  do  not  afford  a  fair 
return  on  the  fair  present  value  of  the  property  used  in  the 
service  of  the  public,  those  rates  are  confiscatory  and  therefore 
unconstitutional.  It  becomes  necessary,  therefore,  in  many  cases 
to  find  such  fair  present  value. 

The  term  value  is  one  of  the  most  uncertain  in  the  dictionary. 
It  may  mean  very  different  things.  The  problem  of  ascertaining 
the  present  value  of  a  complex  operating  property  is  consequently 
necessarily  one  of  those  uncertain  problems,  partly  depending 
upon  engineering  facts,  partly  upon  economic  doctrine,  and 


30 

partly  upon  a  perception  of  justice  and  equity  as  between  the 
public  and  the  owners,  in  which  almost  every  question,  including 
the  desirability  of  a  valuation  at  all,  is  involved  in  controversy ; 
while  upon  some  fundamental  principles  .the  opinions  of  those 
who  might  be  deemed  equally  capable  of  forming  a  judgment 
may  differ  widely.  It  is,  therefore,  not  a  subject  to  be  dealt  with 
by  the  young,  the  immature,  or  the  prejudiced.  It  is  not  a  proper 
subject  for  the  college  curriculum,  except  for  selected  students 
in  graduated  courses.  It  calls  for  the  power  of  logical,  careful 
reasoning,  for  experience,  for  good  judgment,  and  above  all  for 
a  well  balanced  mind,  fair  and  impartial,  which  sees  things  as 
they  are,  has  no  prejudices,  appreciates  the  wide  bearings  of 
the  subject,  can  judge  of  remote  consequences,  can  disentangle 
conflicting  threads  of  argument,  and  can  take  the  broadest  and 
sanest  view  of  the  relations  of  the  public  to  the  individual.  The 
problems  of  valuation  are  indeed  more  dependent  for  a  correct 
solution  upon  attitude  of  mind  and  capacity  for  logical  thought 
than  upon  anything  else,  and  next  upon  experience,  that  great 
and  only  teacher. 

Where  almost  every  point  involved  is  the  subject  of  contro- 
versy and  difference  of  opinion  it  is  difficult  to  select  any  special 
points  for  discussion ;  yet  it  seems  not  inappropriate  to  choose 
a  few  of  the  fundamental  principles,  and  to  outline  some  of  the 
main  differences  between  opposing  points  of  view.  I  do  this  the 
more  readily  because  of  the  increasing  popular  attention  that 
the  subject  is  attracting,  and  in  the  hope  that  if  some  of  you  have 
not  yet  thought  deeply  upon  these  questions  it  may  suggest  some 
ideas,  and  indicate  to  you  the  many  uncertainties  of  the  subject 
and  the  necessity  for  careful  consideration  of  many  points  of 
view  before  arriving  at  a  conclusion.  My  own  personal  views 
are,  naturally,  strenuously  opposed  by  those  who  think  differently. 
My  only  excuse  for  speaking  of  this  subject  lies  in  its  increasing 
popular  importance,  and  in  the  fact  that  circumstances  have 
called  upon  me,  during  the  past  ten  years,  to  make  valuations  of 
property  aggregating  nearly  two  billion  dollars  in  value,  so  that, 
at  all  events,  however  I  may  lack  in  judgment  or  sanity  I  cannot 
be  charged  with  inexperience. 


31 

As  a  primary  basis  for  ascertaining  fair  present  value  the 
following  are  available: 

1.  The  cost  of  the  property  to  date ;  new,  or  after  deduct- 
ing depreciation. 

2.  The  cost  of  reproducing  the  property  at  the  present 
time;  new,  or  after  deducting  depreciation. 

3.  The  market  value  of  its  securities. 

4.  The  capitalized  earnings. 

The  basis  of  the  commercial  value  of  a  public  utility,  or  of 
any  other  commercial  property,  is  plainly  earning  power,  present 
or  potential.  No  one  would  willingly  invest  in  or  buy  such  a 
property  unless  he  could  see  the  prospect  of  a  fair  return.  It 
might  be  earning  nothing,  or  even  losing  heavily  at  the  time,  but 
he  might  not  see  possibilities  of  readjustment,  improvement,  or 
additional  business,  or  other  possibilities  which  would  justify 
him  in  paying  a  considerable  sum  for  the  property.  Most  public 
utilities  are  naturally  and  properly  monopolies.  It  is  not  in  the 
interests  of  the  public  in  the  end  that  two  railroads  should  be 
built  in  the  same  territory  where  one  is  ample  for  the  business. 
If  two  exist,  they  must  to  a  certain  extent,  in  the  public  interest, 
be  operated  as  a  combined  monopoly.  The  days  of  unrestricted 
competition  have  passed.  But  a  public  utility  is  a  monopoly 
which  derives  its  power  in  part  from  a  charter  or  rights  conferred 
upon  it  by  the  public.  It  must,  therefore,  be  subject  to  public 
regulation,  and  must  be  operated  in  such  a  manner  that  none  of 
the  rights  of  the  public,  legal  or  moral,  will  be  infringed.  In  a 
certain  limited  sense  it  is  the  agent  of  the  public  which  has  con- 
ferred upon  it  the  right  to  perform  a  certain  service  which  the 
public  requires. 

The  Supreme  Court  has  recognized  the  above  four  primary 
elements  in  ascertaining  fair  value,  together  with  other  elements 
not  here  mentioned.  In  rate  cases  present  earnings  cannot,  of 
course,  be  considered  as  a  basis,  because  the  object  is  to  fix  the 
rates  and  the  earnings  depend  upon  the  rates.  Some  other  basis 
must  here  be  found.  The  market  value  of  the  securities  can  be 
found  at  any  time  by  an  accountant.  They  may,  however,  be 
temporarily  and  unduly  inflated  or  depressed,  so  that  the  market 
value  at  any  given  time  may  not  represent  the  value  of  the 


32 

property.  There  remain  the  other  two  bases  of  value,  viz. :  the 
original  cost  and  the  cost  of  reproduction ;  and  the  first  point  to 
which  I  wish  to  direct  your  attention  is  the  great  difference  of 
opinion  which  exists  with  reference  to  these  two  methods  of 
finding  value.  Each  has  its  ardent  advocates.  It  is  claimed  on 
the  one  hand,  in  favor  of  original  cost,  that  this  represents  the 
sacrifice  which  the  owners  have  made  to  produce  the  property, 
and  that  they  are  entitled  to  a  fair  return  upon  no  more  than  this 
sum,  or,  if  the  property  is  taken,  to  a  payment  of  no  more  than 
this  sum. 

As  one  college  economist  expresses  it, 

On  any  sound  principle  there  should  be  no  valuation  for  rate 
regulation  but  history,  that  is,  a  statement  of  outlay,  of  money 
spent  and  services  rendered,  nothing  more.  ...  As  an  agent  the 
utility  exercises  the  right  of  eminent  domain,  must  give  an  account 
of  its  stewardship,  is  subject  to  continuous  control,  is  liable  for 
compulsory  service,  and  must  cooperate  with  all  other  public  agents 
of  its  principals,  the  State. 

It  is  held  by  this  writer,  and  by  some  others,  that  the  relation 
between  the  public  and  the  utility  company  is  strictly  the  legal 
relation  of  principal  and  agent.  Your  able  California  attorney, 
Mr.  Max  Thelen,  among  others,  takes  this  view.  The  advocates 
of  this  view  hold  that  the  agent  is  only  entitled  to  receive  his 
expenses  and  fair  compensation  for  his  services,  and  that  if  he 
makes  a  profit  he  "may  be  held  as  a  trustee  and  compelled  to 
account  to  his  principal  for  all  profits  and  advantages  acquired 
by  him  out  of  the  relationship."  This  leads  them  to  the  con- 
clusion that  a  public  utility  should  receive  a  return  only  "on  the 
money  reasonably  and  properly  expended  in  the  acquisition  and 
construction  of  its  works  actually  and  properly  in  use  to  carry 
out  its  agency,  no  more  and  no  less."  If  lands  were  donated  by 
the  State  to  the  company  to  enable  it  to  construct  its  works,  the 
company  is  not  to  be  allowed  to  earn  any  return  upon  those  lands 
when  they  have  become  valuable,  or  if  it  acquires  lands  at  a  low 
cost  it  is  only  to  be  allowed  a  return  upon  such  actual  cost. 

On  the  other  hand,  this  view  is  rejected  by  most  students  of 
the  subject.  It  seems  far-fetched  and  fanciful  to  most  people, 
and  it  has  never  had  the  sanction  of  the  highest  courts.  Those 
who  oppose  it  urge  that  while  a  public  utility  may  be  termed  in 
a  limited  sense  the  agent  of  the  public,  it  is  in  no  sense  a  legal 


33 

agent.  The  conclusions  above  stated  clearly  do  not  follow  when 
the  principal  has  allowed  that  agent  to  manage  the  property  for 
years  without  supervision  or  restriction  and  perhaps  at  a  loss, 
and  without  a  definite  understanding  at  the  beginning  as  to  the 
legal  relation  between  the  parties,  has  allowed  it  to  charge  what 
rates  it  pleased,  subject  to  competition,  to  earn  what  profits  it 
could,  to  go  through  bankruptcy,  perhaps  several  times,  without 
interference  by  the  principal.  They  urge  that  rights  were  given 
to  the  company  by  its  charter  because  those  rights  were  necessary 
to  enable  the  works  to  be  constructed,  for  without  the  power  of 
taking  land  by  eminent  domain  it  would  probably  be  practically 
impossible  to  construct  a  railroad.  They  urge  that  public  lands 
were  given  originally  in  some  cases  because  without  giving  them 
the  public  could  not  induce  the  company  to  build  the  works,  and 
that  once  given  they  are  the  property  of  the  company,  like  any 
other  private  property;  they  maintain  that  the  public  desired 
the  works  to  be  built  because  it  saw  that  1Jiey  were  essential  for 
the  prosperity  of  the  State,  but  that  the  risk  of  loss  was  left 
entirely  with  the  company,  and,  therefore,  that  it  should  have 
the  ownership  of  its  property  and  the  possibility  of  profits  when 
they  become  possible.  They  say  that  lands  originally  given  to 
the  company  by  the  state  were  given  absolutely,  without  con- 
dition or  agreement,  that  they  were  intended  to  be,  and  have 
always  been  considered  to  be  the  obsolute  property  of  the  com- 
pany, that  they  were  given,  as  a  matter  of  fact,  in  consideration 
of  advantages  which  the  public  expected  to  receive  in  compensa- 
tion and  which  the  public  has  actually  received  manifold  in 
compensation.  They  say  that  if  the  company  was  merely  the 
legal  agent  of  the  public  that  relationship  should  have  been  estab- 
lished and  understood  by  both  parties  at  the  beginning,  which 
has  never  been  the  case.  They  say  that  if  the  legal  relation  of 
principal  and  agent  is  to  hold,  the  agent  must  be  subject  to  the 
continual  supervision  of  the  principal,  and  that  after  allowing 
a  railroad  company  to  manage  its  own  affairs  for  decades,  to  go 
through  foreclosures  and  receiverships  without  any  guarantee 
of  protection  against  loss  on  the  part  of  the  principal,  it  is  in- 
equitable and  illegal  for  the  principal  at  a  later  time  to  step  in, 
claiming  that  the  legal  relation  of  principal  and  agent  is  to  be 
assumed  and  that  the  company,  after  it  has  become  prosperous, 


34 

is  then  to  be  allowed  to  earn  no  more  than  a  fair  return  upon 
the  original  cost. 

Moreover,  the  highest  courts  have  stated,  again  and  again, 
that  while  it  is  at  least  the  present  value  of  the  property  which 
the  company  employs  for  the  public  convenience  which  is  entitled 
to  a  fair  return  in  rates,  or  to  be  paid  as  compensation  in  a 
taking,  this  fair  value  is  not  the  original  cost  thereof.  For 
instance,  in  San  Diego  Land  and  Town  Co.  vs.  Jasper,  189  U.  S. 
442,  the  court  said: 

The  main  object  of  attack  is  the  valuation  of  the  plant.  It  no 
longer  is  open  to  dispute  that  under  the  Constitution  what  the  com- 
pany is  entitled  to  demand  in  order  that  it  may  have  just  com- 
pensation is  a  fair  return  upon  the  reasonable  value  of  the  property 
at  the  time  it  is  being  used  for  the  public. — San  Diego  Land  and 
Town  Co.  vs.  National  City,  174  U.  S.  793-757. 

That  is  decided  and  is  decided  as  against  the  contention  that 
you  ought  to  take  actual  cost  of  the  plant,  annual  depreciation,  etc., 
and  to  allow  a  fair  profit  on  that  footing,  over  and  above  expenses. 

Again,  in  the  Minnesota  Rate  Cases,  230  U.  S.  454,  the  court 
said : 

It  is  clear  that  in  ascertaining  the  present  value  we  are  not 
limited  to  the  consideration  of  the  amount  of  the  actual  investment. 
If  that  has  been  reckless  or  improvident  losses  may  be  sustained 
which  the  community  does  not  underwrite.  As  the  company  may 
not  be  protected  in  its  actual  investment,  if  the  value  of  its  prop- 
erty be  plainly  less,  so  the  making  of  a  just  return  for  the  use  of 
the  property  involves  recognition  of  its  fair  value  if  it  be  more 
than  its  cost.  The  property  is  held  in  private  ownership  and  it  is 
that  property  and  not  the  original  cost  of  it  of  which  the  owner  may 
not  be  deprived  without  due  process  of  law.  [Italics  mine.  G.  F.  S.] 

The  advocates  of  the  original  cost  theory  are  always  careful  to 
remark  that  the  first  cost  is  not  to  be  taken  if  the  company  has 
been  wasteful  or  extravagant,  that  is,  if  the  value  is  less  than 
that  cost ;  but  they  strenuously  oppose  making  any  additions  to 
that  first  cost  if  the  investment  has  been  skillfully  made  and  has 
resulted  in  an  increased  value  to  the  property. 

As  a  matter  of  fact,  the  first  cost  theory  does  place  a  premium 
upon  and  encourage  wasteful,  extravagant,  and  inefficient  con- 
struction. Every  engineer  knows  that  there  is  a  wide  range 
within  which  the  cost  of  construction  may  be  reasonable.  In  a 
case  in  which  the  speaker  was  recently  consulted  there  were  four 
bids  for  constructing  a  certain  property,  all  by  responsible  and 
skilled  contractors.  The  highest  three  bids  were  close  together, 
although  there  was  no  evidence  of  collusion,  and  were  double  the 


35 

lowest  bid.  The  latter  proved  to  be  too  low,  and  the  contractor 
lost  money;  his  actual  cost  being  about  two-thirds  that  of  the 
highest-bidder.  Even  the  highest  bid  could  not  have  been  con- 
sidered an  unreasonable  one. 

When  a  railroad  is  constructed  it  is  given  certain  rights  by 
the  public,  but  those  rights  are  only  those  which  are  necessary 
in  order  to  secure  the  construction.  A  railroad  is  given  the  right 
of  eminent  domain  because  without  that  right  it  would  be  im- 
practicable to  build  the  road.  So  of  the  right  given  to  a  street 
railway  company  to  lay  its  tracks  in  the  streets,  or  to  a  gas  com- 
pany to  lay  its  mains  in  the  streets.  The  public  grants  the 
rights  because  it  wants  the  commodity  which  the  utility  is  to 
furnish.  Not  infrequently  it  is  more  anxious  to  grant  the  charter 
than  the  company  is  to  receive  it.  It  leaves  the  company  un- 
restricted for  many  years  in  the  conduct  of  its  business  and  in 
its  financial  management,  and  finally  comes  in  to  regulate  it  and 
to  fix  its  value.  In  the  meantime  the  community  has  grown, 
lands  which  perhaps  were  donated  to  the  company  have  increased 
in  value  in  common  with  all  other  lands  in  the  neighborhood, 
largely  due  to  the  presence  of  the  utility,  and  now  it  is  said  by 
the  advocates  of  original  cost  that  since  those  lands  were  donated 
to  the  company  it  is  not  to  be  allowed  to  earn  any  return  upon 
the  value  of  those  lands,  because  the  public  should  not  be  required 
to  pay  any  rates  for  what  it  has  itself  given.  In  the  meantime 
the  property  may  have  changed  hands  a  dozen  times  at  prices 
determined  by  the  competitive  theory,  that  is  to  say,  based  upon 
the  earnings  which  the  public  has  allowed  the  company  to  make 
without  restriction.  The  original  company  may  have  been  suc- 
ceeded several  times  by  new  companies.  Nevertheless,  they  claim 
it  is  now  to  be  allowed  to  earn  a  return  only  upon  the  original 
cost,  notwithstanding  the  decisions  of  the  courts  that  costs  is  not 
value. 

The  decisions  of  the  courts  are  no  stumbling  block  in  the  way 
of  some  of  those  who  advocate  this  theory,  and  one  of  them,  a 
college  economist,  sweeps  the  difficulties  away  by  saying  that  the 
present  uncertainties  and  unsatisfactory  condition  are  due  to 
these  decisions  of  the  Supreme  Court  and  that  they  will  continue 
until  that  Court  is  compelled  by  public  opinion  to  reverse  itself 
or  until  its  power  is  changed  by  constitutional  amendment.  This 


36 

illustrates  the  character  of  much  of  the  discussion  on  this  ques- 
tion. The  author  referred  to  evidently  considers  that  he  and  he, 
alone,  and  those  who  agree  with  him,  are  infallible,  that  anybody 
who  disagrees  with  him  is  wrong,  including  the  Supreme  Court 
of  the  United  States,  which  must  be  compelled  to  reverse  itself. 

In  connection  with  the  original  cost  theory  it  is  also  asked  by 
some,  in  case  its  value  is  to  be  ascertained  on  the  basis  of  first 
cost,  just  what  is  meant?  The  first  cost  to  whom?  To  the 
owners,  or  to  previous  owners?  If  your  property  is  to  be  taken 
from  you  on  the  basis  of  its  original  cost,  should  that  be  its  cost 
to  you  or  to  somebody  else?  It  is  urged,  for  instance,  that  cer- 
tain individuals  might  get  together,  obtain  a  franchise,  and  build 
a  railroad.  They  may  be  shrewd  and  far-sighted,  may  locate  the 
road  with  exceptional  skill,  and  may  build  it  under  exceptionally 
favorable  conditions  when  prices  are  very  low,  or  perhaps  when 
they  can  get  certain  of  the  work  done  at  prices  which  can  never 
be  again  obtained.  For  instance,  they  may  be  able  to  get  a 
good  deal  of  their  grading  or  filling  done  for  nothing,  or  they 
may  even  be  paid  for  it,  for  somebody  else  at  the  moment  may 
have  a  large  quantity  of  earth,  taken  perhaps  from  a  subway  or 
tunnel  in  a  city,  which  he  wants  to  dispose  of,  and  unless  he  can 
dispose  of  it  to  the  utility  he  will  have  to  pay  a  large  sum  to 
carry  it  elsewhere.  He  may,  therefore,  be  willing  to  dispose  of  it 
to  the  utility  and  to  place  it  for  next  to  nothing  or  even  to  make 
a  payment  therefore.  At  all  events,  the  road  may  be  supposed  to 
be  constructed  at  an  extremely  low  cost.  It  fills  a  need  and 
develops  a  good  business,  and  a  few  years  afterward  some  new 
parties  appear  and  seeing  that  it  was  built  most  economically 
and  has  great  possibilities,  they  may  buy  it  from  the  original 
builders  at  a  large  advance  over  what  the  latter  paid  for  it,  and 
yet  perhaps  less  than  it  would  cost  them  at  the  time  to  reproduce 
it,  or  to  build  another  road.  They  buy  it  at  that  price.  Years 
go  by  and  the  property  becomes  subject  to  public  regulation,  and 
is  now  to  be  taken  for  public  purposes,  or  its  rates  fixed.  Is  it 
equitable  to  pay  the  new  owners  what  they  paid  for  it  or  what 
their  predecessors  paid  for  it? 

Of  course  the  answer  which  is  made  to  this  suggestion  by  those 
who  hold  the  theory  of  principal  and  agent  is  that  the  agent  of 
the  public  is  the  company  and  not  the  individuals  who  happen  to 


37 

own  it  and  hence  individual  ownership  is  of  no  consequence. 
But  how  is  this  when  not  simply  the  stockholders  have  changed, 
but  when  the  original  corporation  has  been  suceeded  by  a  new 
one  ?  Is  the  new  corporation  the  agent,  or  not  ?  If  it  is,  then  the 
cost  to  it  should  be  taken ;  if  it  is  not,  the  whole  theory  falls. 

The  case,  however,  is  certainly  not  so  simple  as  some  would 
make  it  appear,  nor  can  it  be  decided  offhand  by  simply  asserting 
that  the  Supreme  Court  is  all  wrong.  Certain  it  is  that  the 
theory  of  principal  and  agent,  and  the  use  of  first  cost,  if  applied 
as  some  have  urged  that  it  should  be  applied  would  very  likely 
wipe  out  millions  of  dollars  of  investment  honestly  made  and 
even  sanctioned  by  regulating  commissions. 

Moreover,  the  theory  of  first  cost,  it  is  claimed,  leaves  entirely 
out  of  account  the  element  of  competition,  which  still  remains 
to  a  certain  extent,  though  under  regulation.  There  may  be  two 
railroad  lines  between  the  same  two  cities,  and  extending  no 
farther.  One  of  them  necessarily  has  the  best  location  and 
originally  cost  much  less  than  the  other.  If  the  rates  are  to  be 
based  upon  original  cost  the  more  cheaply  built  road  will  obtain 
all  the  business,  and  the  building  of  new  roads  will  be  absolutely 
prevented.  This  argument,  of  course,  applies  equally  to  the  cost 
of  reproduction  theory,  and  indicates  that  as  a  basis  for  rates 
neither  result  is  at  all  conclusive.  Would  this  not  be  true  equally 
in  case  of  a  taking?  If  the  public  should  take  the  more  econom- 
ically built  road  at  its  original  cost  it  would  thereby  become  pos- 
sessed of  an  asset  with  which  it  could  wage  war  against  the  later 
and  more  expensive  road,  to  the  extermination  of  the  latter, 
although  it  had  chartered  it  and  was  equally  its  principal.  It  is 
asked  whether  the  state  should  use  its  paramount  powers  to  ruin 
agencies  that  it  has  itself  authorized.  To  many  it  is  clear  that 
no  valuation  has  much,  if  any,  relation  to  rates,  which  should  be 
determined  by  what  the  traffice  will  bear. 

By  some  it  is  considered  that  public  ownership  is  the  only 
solution  of  these  problems,  but  the  experience  with  public  owner- 
ship is  decidedly  against  its  advantage  to  the  public,  and  especi- 
ally in  a  democracy  it  would  be  a  distinct  public  menace. 

Another  consideration  is  urged  with  reference  to  the  original 
cost  theory.  If  the  basis  of  this  theory  is  that  it  is  the  sacrifice 
made  by  the  agent  which  is  the  basis  of  value,  it  must  be  his 


38 

total  sacrifice,  and  if  in  any  years  of  the  enterprise  he  did  not 
receive  a  fair  return  on  his  investment  any  deficiency  below  a 
fair  return  must  be  added  to  that  investment  and  compounded 
from  year  to  year.  Additions  of  this  kind  may  easily  result  in  a 
great  increase  above  the  original  cost  investment.  Moreover,  it 
is  not  only  the  cost  of  the  property  that  is  to  be  taken  but  also 
the  cost  of  developing  the  business  to  its  present  condition, 
including  all  expenditures,  direct  or  indirect. 

Your  able  California  attorney,  Mr.  Thelen,  appears  to  hold 
this  view,  for  he  quotes  with  approval  from  a  decision  by  another 
eminent  Californian,  Secretary  Lane,  who  in  the  Western  Ad- 
vance Rate  Case  said : 

Perhaps  the  nearest  approximation  to  a  fair  standard  is  that  of 
bona  fide  investment,  the  sacrifice  made  by  the  owners  of  the 
property,  considering  as  part  of  the  investment  any  shortage  of 
return  that  there  may  be  in  the  early  years  of  the  enterprise.  Upon 
this,  taking  the  life  history  of  the  road  through  a  number  of  years,, 
its  promoters  are  entitled  to  a  reasonable  return.  This,  however, 
manifestly  is  limited,  for  a  return  should  not  be  given  upon  waste- 
fulness, mismanagement,  or  poor  judgment,  and  always  there  is 
present  the  restriction  that  no  more  than  a  reasonable  rate  shall 
be  charged. 

Those  who  oppose  the  original  cost  method  fail,  however,  to 
see  why  Mr.  Lane  should  limit  the  shortage  of  return  to  the  early 
years  of  the  enterprise,  or  why  every  shortage  from  the  beginning 
to  the  time  of  decision  should  not  be  allowed.  They  maintain 
also  that  if  from  the  original  cost  is  to  be  deducted  any  losses 
due  to  "wastefulness,  mismanagement,  or  poor  judgment,"  then 
there  should  also  be  allowed  any  profits  accruing  from  economy, 
efficient  management,  and  good  judgment;  and  admitting  that 
there  is  always  present  the  restrictions  that  no  more  than  a 
reasonable  rate  shall  be  charged,  which  Mr.  Lane  implies  is  a 
restriction  independent  of  first  cost,  they  claim  that  this  means 
also  that  no  less  than  a  reasonable  rate  shall  be  charged,  that  is, 
a  reasonable  recompense  for  the  service  rendered,  also  entirely 
independent  of  first  cost. 

Against  this  view  that  deficiencies  of  earnings  should  be  in- 
cluded in  original  cost,  it  is  urged  by  some  that  the  mere  physical 
property  would  be  worth  nothing  aside  from  its  operation,  that 
the  construction  of  the  property  means  constructing  a  property 
that  has,  or  is  capable  of  having,  business,  but  which  without 


39 

the  business  is  valueless.  Giving  the  physical  bare  bones  a  value 
is  only  justified,  they  say,  if  it  has  the  business  too.  They  refuse, 
therefore,  to  allow  any  deficiency  of  earnings.  In  taking  this 
ground  they  clearly  abandon  the  position  that  the  sacrifice  of  the 
owners  is  the  fair  value  of  the  property.  As  for  the  capitalization 
of  a  deficiency  in  earnings  it  is  also  urged  by  a  few  that  this 
would  amount  to  a  guarantee  by  the  public  of  a  fair  return, 
which  they  say  the  public  can  never  make  even  though  it  is  a 
principal.  This  view,  however,  clearly  involves  a  fallacy  in  regard 
to  the  meaning  of  the  word  guarantee.  To  allow  a  capitalization 
of  a  deficiency  of  earnings  is  not  to  guarantee  a  fair  return.  The 
public,  of  course,  should  never  guarantee  a  public  service  cor- 
poration, which  it  charters,  against  being  a  losing  venture;  but 
ought  it  not  to  guarantee  to  it  rates  which,  if  those  rates  will 
produce  the  traffic,  that  is,  if  the  traffic  will  bear  those  rates, 
will  prevent  it  from  being  a  losing  venture?  As  the  price  of  any 
commodity,  including  transportation,  is  raised,  the  demand  for 
it  generally  decreases.  At  some  point  the  price  will  result  in  a 
demand  which  will  produce  the  maximum  return.  That  maxi- 
mum return  may  not  be  enough  to  constitute  a  fair  return  on  the 
investment.  In  this  case  the  concern  is  a  losing  venture,  and 
the  public  cannot  guarantee  it,  and  ought  not  to  guarantee  it 
against  such  contingency.  But,  on  the  other  hand,  if  the  public 
is  to  regulate  rates  and  values,  ought  it  not  to  guarantee  a  rate 
high  enough  to  produce  a  fair  return  even  on  a  value  which 
includes  deficiency  of  earnings  in  previous  years,  if  such  a  result 
is  possible?  If  this  view  is  not  taken  no  one  will  invest  in  a 
public  utility.  If  you  invest  in  a  public  utility  you  take  some 
risk.  You  are  willing  to  take  the  risk  because  your  judgment 
tells  you  that  the  concern  will  be  a  success,  but  would  you  make 
the  investment  if  you  knew  that  the  public  was  to  come  in  later 
and  prevent  your  receiving  even  a  fair  return  on  your  invest- 
ment from  the  beginning  though  it  might  become  capable  of  pro- 
ducing large  returns?  These  illustrations  are  not  fanciful. 
Street  railways  in  many  parts  of  the  country  are  in  a  condition 
which  justifies  them.  In  Massachusetts  they  have  become  so 
seriously  crippled  that  the  public  is  not  obtaining  anything  like 
the  service  that  it  ought  to  have.  The  shares  of  one  corporation, 
in  whose  capitalization  there  is  admittedly  not  a  dollar  of  water, 


40 

which  has  been  under  public  regulation  from  the  beginning  and 
some  of  whose  stock  has  been  issued  at  a  price  of  $155  a  share, 
as  fixed  by  the  state  regulating  body  at  the  time,  has  been 
recently  selling  for  under  $30. 

The  theory  of  cost  of  reproduction  as  a  basis  of  value  has 
also  its  defects  and  opponents.  Those  who  oppose  it  are  par- 
ticularly active  and  caustic  in  their  criticism.  They  designate  it 
by  all  sorts  of  epithets.  One  eminent  critic  of  this  theory  and 
advocate  of  the  original  cost  theory  says  that  the  reproduction 
cost  theory  is  "utterly  dishonest."  This  critic  knows  perfectly 
well  that  the  Supreme  Court  in  at  least  two  decisions  has  spoken 
favorably  of  this  theory.  In  the  Knoxville  case  the  Court  said : 

The  cost  of  reproduction  is  one  way  of  ascertaining  the  present 
value  of  a  plant  like  that  of  a  public  utility  company,  but  that  test 
would  lead  to  obviously  incorrect  results  if  the  cost  of  reproduction 
is  not  diminished  by  the  depreciation  which  has  come  from  age 
and  use. 

In  the  Minnesota  rate  case  the  Court  said : 

The  cost  of  reproduction  method  is  of  service  in  ascertaining 
the  present  value  of  the  plant  when  it  is  reasonably  applied,  and 
when  the  cost  of  reproducing  the  property  may  be  ascertained  with 
a  proper  degree  of  certainty,  but  it  does  not  justify  the  acceptance 
of  results  which  depend  upon  mere  conjecture. 

Moreover,  the  same  court  in  a  later  case,  that  of  the  Des 
Moines  Gas  Co.  (238  U.  S.  153),  distinctly  upheld  the  cost  of 
reproduction  method,  saying,  in  approval  of  what  had  been  done : 

After  valuing  the  real  estate  and  various  items  of  personal 
property,  as  hereinafter  stated,  the  master  adopted  as  the  only 
practical  way,  in  his  judgment,  of  determining  the  reasonable  value 
of  the  buildings,  their  contents,  yard  structures,  and  the  mains, 
house  and  street  lamp  service,  and  meters,  the  test  of  estimating 
the  cost  of  reproducing  them  new  and  then  estimating  the  deprecia- 
tion which  should  be  deducted  in  order  to  obtain  their  present  value. 

Notwithstanding  these  decisions  of  our  highest  court  this  critic 
says  the  theory  is  "utterly  dishonest." 

Those  who  oppose  the  cost  of  reproduction  method  sometimes 
intimate  that  it  is  only  used  by  those  who  desire  to  arrive  at  a 
high  valuation.  Thus,  the  same  critic  said,  in  an  official  decision, 
"The  reproduction  cost  theory  has  during  recent  years  become  a 
fashionable  one  among  many  attorneys  and  managers  of  public 
service  corporations."  He  perhaps  forgets  that  in  the  leading 
case  of  Smyth  vs.  Ames,  counsel  for  the  railroad  maintained  that 


41 

the  original  investment  should  be  the  basis.  It  appears  that, 
when  the  roads  were  built,  wages  were  above  normal,  prices  high, 
and  gold  at  a  heavy  premium,  and  that  when  the  action  was 
brought  prices  had  materially  declined,  so  that  it  was  estimated 
that  the  roads  could  then  be  reproduced  for  less  than  the  original 
cost.  On  the  other  hand,  counsel  for  the  state  then  maintained 
that  "the  present  value,  as  measured  by  the  cost  of  reproduc- 
tion ' '  was  the  proper  basis.  Hence  the  critic  might  equally  well 
have  said  that  the  original  cost  theory  had  during  recent  years 
become  a  fashionable  one  among  many  attorneys  for  and  members 
of  public  commissions.  The  value  of  the  theory  is  to  be  judged 
not  by  the  persons  who  hold  it,  but  by  its  own  merits  and  the 
decisions  of  the  highest  courts,  which  we  should  always  respect 
though  we  may  personally  disagree  with  them. 

Those  who  uphold  the  cost  of  reproduction  theory,  so  far  as 
I  have  read  their  views,  appear  to  be  more  reasonable  and  mod- 
erate in  their  expressions.  They  respect  the  opinions  of  the 
Supreme  Court  and  neither  term  them  utterly  dishonest  nor  say 
that  the  Court  must  be  forced  to  reverse  itself.  Most  of  them 
appear  to  believe,  as  the  Supreme  Court  does,  that  neither  repro- 
duction cost  nor  original  cost  is  alone  the  criterion,  though  they 
believe  that  cost  of  reproduction,  properly  ascertained,  is  much 
nearer  to  fair  present  value  than  original  cost,  while  some  of  the 
writers  who  support  the  original  cost  theory  apparently  maintain 
that  it  and  they  alone  are  infallible.  The  advocates  of  the  repro- 
duction cost  theory  urge,  certainly  not  without  reason,  that  if, 
as  the  Supreme  Court  has  said,  it  is  the  fair  present  value  of  the 
property  which  is  to  be  the  basis,  then  let  us  suppose  the  follow- 
ing case: 

Suppose  a  railroad  passes  through  a  town.  It  has  its  right  of 
way,  its  bridges,  its  embankments.  The  problem  is  to  find  the 
present  value.  Suppose  it  should  build  a  branch  from  its  station 
in  that  town,  diverting  from  its  main  line.  It  would  have  to  buy 
property,  build  bridges  and  embankments.  On  the  original  cost 
theory,  which  no  doubt  here  applies,  the  cost  of  its  right  of  way 
would  be  its  value.  They  ask  then,  is  the  present  value  of  the 
right  of  way  of  the  main  line,  only  one  hundred  feet  away,  built 
fifty  years  ago,  which  goes  through  precisely  similar  property, 
any  less  than  the  value  of  the  branch  right  of  way  just  built 


42 

simply  because  it  was  built  earlier?  Extend  the  illustration. 
Suppose  that  the  railroad  company  needs  to  enlarge  its  yard  and 
must  widen  its  right  of  way  or  take  a  block  adjoining  one  which 
it  already  possesses.  It  takes  that  property,  enlarges  its  yard, 
builds  its  embankments  and  bridges  if  necessary.  The  cost  of 
that  new  property  is  its  value  at  the  time.  Is  the  value  of  the 
other  block  previously  existing  any  less?  It  is  in  exactly  the 
same  locality  and  under  similar  conditions.  .Why,  they  say, 
should  there  be  a  difference  in  the  present  value  ? 

Those  who  advocate  the  original  cost  method  are  seriously 
disturbed  by  the  fear  that  the  use  of  the  cost  of  reproduction 
method  will  lead  to  rapidly  increasing  values  and  rates.  Thus 
Commissioner  Lane,  in  the  Western  Advance  Rate  case,  referring 
to  the  contention  of  the  Burlington  Road  that  it  was  entitled  to 
a  return  on  unearned  increment  in  land  value,  said : 

If  this  is  a  precise  expression  of  what  our  courts  will  hold  to 
be  the  law,  then,  as  we  are  told,  there  is  certainly  the  danger  that 
we  may  never  expect  railroad  rates  to  be  lower  than  they  are  at 
present.  On  the  contrary  there  is  the  unwelcome  promise  made  in 
this  case  that  they  will  continuously  advance. 

and  he  adds: 

In  the  face  of  such  an  economic  philosophy,4  if  stable  and  equit- 
able rates  are  to  be  maintained  the  suggestion  has  been  made  that 
it  would  be  wise  for  the  Government  to  protect  its  people  by  taking 
to  itself  these  properties  at  present  value  rather  than  to  await  the 
day,  perhaps  twenty  or  thirty  years  hence  when  they  will  have 
multiplied  in  value  ten  or  twenty  fold. 

In  the  case  of  Buffalo  Gas  Co.  vs.  City  of  Buffalo  (N.  Y.  Public 
Service  Commission,  2nd  District,  Vol.  3,  633),  the  Commission 
said : 

A  valuation  made  in  the  case  of  this  company  in  1907  would 
produce  vastly  different  results  from  a  valuation  made  in  1912, 
owintr  to  the  different  prices  of  pipe,  and  yet  there  can  scarcely  be 
any  disagreement  upon  the  proposition  that  the  price  of  gas  in  1907 
and  1912  should  be  substantially  the  same.  A  condition  of  things 
which  permits  the  public  to  appeal  to  this  Commission  to  fix  the 
rate  in  times  of  financial  distress  when  materials  are  low  and  labor 
is  cheap  and  thereby  obtain  a  low  rate  which  shall  obtain  perman- 
ently or  substantially  so;  and  on  the  other  hand  which  permits  the 
company  to  appeal  to  the  Commission  to  fix  a  rate  at  a  time  when 
labor  is  high  and  materials  are  dear,  and  thereby  fix  a  higher  rate 
to  continue  with  a  substantial  permanency,  is  intolerable.  If  the 
Commission  were  to  fix  the  price  of  iron  pipe  upon  the  prices  now 
prevailing,  next  .year  they  may  be  50  degrees  higher.  Justice  would 
require  that  the  rate  go  up  if  the  cost  of  reproduction  now  is  to 
prevail;  while,  on.the  other  hand,  if  pipe  gets  lower  the  rates  should 
be  lower.  This  would  require  a  constant  juggling  with  prices  in 
order  to  carry  out  what  would  be  deemed  substantial  justice. 


43 

To  these  criticisms  of  the  method  the  following  reply  may  be 
made. 

In  the  first  place,  Secretary  Lane's  suggestion,  that  railroad 
values  may  be  multiplied  ten  or  twentyfold,  is  an  exaggeration. 
His  fear  seems  to  have  reference  mainly  to  the  increase  of  land 
values,  since  values  of  the  other  elements  may  be  expected  to 
fluctuate  up  and  down,  generally  speaking ;  but  the  value  of  land 
in  a  railroad  valuation  is,  on  the  average,  only  from  about  15  per 
cent  to  25  per  cent  of  the  total  value,  so  that  if  land  values 
should  be  multiplied  ten  times,  which  is  very  excessive,  with  other 
values  unchanged  on  the  average  the  total  value  of  the  property 
would  be  increased  only  about  three  times  instead  of  "ten  or 
twentyfold." 

Secretary  Lane  seems  to  think  that  railroad  rates  should  be 
expected  to  be  lower  in  future  than  at  present,  and  the  New  York 
Public  Service  Commission  seem  to  think  that  the  price  of  gas 
should  remain  substantially  the  same.  The  price  of  money,  of 
labor,  of  every  material  thing,  varies  from  year  to  year,  and  it 
may  be  pertinent  to  ask  why  it  should  be  assumed  that  the  price 
of  transportation  or  of  gas  should  remain  the  same  or  should  fall. 
It  is,  of  course,  desirable  that  rates  should  remain  stable,  and, 
if  public  service  companies  are  allowed  to  earn  a  fair  surplus  to 
provide  for  fluctuations  from  year  to  year,  they  will  remain 
fairly  stable,  as  compared  with  the  prices  of  materials  or  money. 
The  price  of  a  thing  changes  either  because  of  conditions  affect- 
ing it,  which  change  its  value,  including  among  these  supply  and 
demand,  or  because  of  a  general  change  in  the  value  of  a  dollar. 
If,  by  reason  of  an  excess  of  currency,  the  value  of  the  dollar 
decreases,  that  is  to  say,  if  it  takes  more  dollars  to  buy  a  given 
thing,  why  should  transportation  or  gas,  which  are  commodities, 
be  exempt  from  the  general  change  in  price? 

Further,  with  reference  to  Secretary  Lane's  suggestion,  it  is 
very  doubtful  in  the  minds  of  a  great  many  people  if  protecting 
the  people  means  limiting  the  taxes  and  other  charges  imposed 
upon  them,  whether  the  taking  possession  of  the  properties  by 
the  government  will  protect  the  people.  The  experience  with 
government  ownership  does  not  show  that  it  leads  to  decreased 
charges,  although  it  may  be  possible  to  hide  those  charges  in  the 
general  tax  levy  so  that  the  average  man  may  lose  sight  of  them. 


44 

Certainly  many  intelligent  and  unprejudiced  men  believe  that  a 
great  disillusioning  will  come  upon  the  American  people  if  they 
resort  to  government  ownership  in  the  hope  of  reducing  charges. 
Further,  with  reference  to  the  statement  of  the  New  York 
Public  Service  Commission,  it  may  be  said  that  those  who  believe 
in  the  cost  of  reproduction  method  do  not  as  a  rule  look  upon  a 
valuation  as  a  thing  to  be  made  from  year  to  year  or  whenever 
demanded  by  the  public  or  the  corporation.  With  the  increase 
of  public  control,  assuming  the  desirability  of  ascertaining  the 
physical  value  of  public  utility  properties  or  the  necessity  of 
doing  so  in  some  cases,  these  people  maintain  that  such  values 
should  be  ascertained  once  for  all  simply  as  a  starting  point. 
They  believe  that  the  past  should  be  wiped  out,  and  a  new  start 
made,  that  any  past  errors  on  the  part  of  the  companies  in  the 
wa}'  of  financial  mismanagement  or  overcapitalization,  and  any 
mistakes  on  the  part  of  the  public  in  allowing  such  things  to 
happen,  or  in  allowing  rates  which  are  too  high,  or  rates  which 
were  so  low  as  to  result  in  financial  embarrassment  or  bank- 
ruptcy, should  equally  be  forgotten,  but  that  a  new  start  should 
now  be  made  with  a  valuation  of  the  physical  property  at  the 
present  time,  and  that  hereafter  such  methods  of  accounting  and 
such  rules  controlling  the  issue  of  securities  and  the  application 
of  the  proceeds  should  be  adopted  as  will  insure  that  the  value 
of  the  physical  property  at  a  future  time  can  be  ascertained  on 
the  basis  of  the  present  value  and  the  operating  results  since  it 
was  made.  This  was  even  the  view  of  Director  Prouty,  who,  as 
a  member  of  the  Interstate  Commerce  Commission,  in  an  address 
before  the  National  Association  of  Manufacturers  in  New  York 
in  1907  said: 

The  popular  impression  that  if  the  value  of  our  railroads  were 
known  it  would  be  easy  for  us  to  adjust  rates  that  a  fair  return 
upon  that  value  and  only  a  fair  return  would  be  obtained,  is  entirely 
erroneous.  The  most  that  can  be  done  in  most  cases  in  fixing  the 
value  of  our  railroads  would  be  to  determine  the  cost  of  their 
reproduction  at  the  present  time.  .  .  .  Such  a  valuation  would  .  .  . 
establish,  as  it  were,  a  point  of  departure  today  from  which  future 
values  might  in  some  measure  be  reckoned. 

Commissioner  Prouty  evidently  at  that  time  believed  that  the 
only  thing  that  could  be  done  in  the  case  of  railroads  was  to  use 
the  cost  of  reproduction  method,  and  he  further  evidently  believed 


45 

that  once  applied  it  would  be  not  necessary  to  use  it  again,  but 
that  it  would  serve  as  a  point  of  departure  for  the  future.  This, 
I  think,  is  the  view  taken  by  most  advocates  of  the  cost  of 
reproduction  method. 

These  considerations  may  perhaps  indicate  to  you  the  com- 
plicated character  of  the  problem  and  especially  the  mental 
characteristics  of  some  of  the  individuals  who  deal  with  it.  They 
will  perhaps  substantiate  the  statement  made  at  the  beginning 
of  this  lecture  that  the  attitude  of  mind  with  which  a  subject  of 
this  kind  is  approached  is  perhaps  the  most  important  element 
in  arriving  at  a  correct  conclusion. 

As  illustrating  the  lengths  to  which  some  advocates  of  the 
original  cost  theory  go,  one  of  them  maintains  that  overhead 
expenses  for  engineering,  if  paid  out  of  operating  expenses  after 
the  plant  is  put  into  use  by  members  of  the  regular  staff,  are  not 
to  be  considered  even  in  original  cost.  In  other  words,  if  a 
company  builds  a  temporary  bridge  at  the  beginning,  puts  its 
road  into  operation,  and  subsequently  replaces  this  bridge  by  an 
expensive  steel  structure  designed  by  its  regular  staff  of  engineers, 
the  engineering  expense  connected  with  this  bridge  is  not  to  be 
considered  as  original  cost  because  done  by  the  regular  salaried 
staff.  In  other  words,  this  writer  apparently  believes  that  not 
even  actual  original  cost  is  to  be  used. 

But,  after  all,  much  of  this  discussion  is  purely  academic  in 
view  of  the  fact  that  in  many  cases,  as,  for  instance,  in  the  case 
of  a  railroad  of  considerable  age,  it  is  generally  impossible  to 
ascertain  the  original  cost.  So  far  as  I  know,  no  complete  esti- 
mate of  the  original  cost  of  any  large  railroad  has  yet  been  found, 
or  the  deficiency  in  earnings  in  lean  years  worked  out.  All 
valuations  of  such  roads  have  been  based  on  estimating  the  cost 
of  reproduction.  This  can  be  done  with  comparative  ease,  as  it 
involves  simply  making  an  inventory  of  the  property  and  placing 
upon  each  item  the  cost  of  producing  it  at  the  present  time.  The 
original  cost  cannot  be  found  because,  in  the  first  place,  the 
records  are  in  many  cases  destroyed  or  inaccessible,  and,  in  the 
second  place,  because  in  the  past  accounts  have  not  been  kept 
in  such  a  way  as  to  distinguish  between  amounts  properly  charge- 
able to  replacements  and  amounts  properly  chargeable  to  new 


46 

construction.  "When  our  railroads  were  built  they  were,  as  a 
rule,  constructed  cheaply,  because  the  money  was  not  available 
to  construct  them  in  any  other  way.  As  traffic  grew  and  revenue 
increased,  a  wooden  trestle,  for  instance,  would  be  replaced  by  a 
steel  bridge.  The  entire  cost  of  the  replacement  would  be  charged 
to  operating  expenses.  The  banks  of  a  cut,  originally  with  a 
certain  slope,  would  slide  through  the  action  of  water,  and  addi- 
tional material  would  have  to  be  taken  out  to  make  the  slope  of 
the  banks  less.  This  would  be  charged  to  operating  expenses. 
As  a  matter  of  fact,  the  latter  expense  is  properly  chargeable  to 
the  original  cost  of  producing  the  cut  in  its  later  condition,  as 
the  excess  cost  of  the  steel  bridge  over  the  cost  of  replacing  the 
wooden  trestle  is  also  properly  chargeable  to  original  cost.  It  is 
probably  impossible  to  disentangle  these  accounts  at  the  present 
time  in  such  a  way  as  to  ascertain  the  original  cost  of  a  large 
railroad. 

It  may  be  urged  that  the  accounts  should  have  been  kept  in 
such  a  manner  as  to  capitalize  all  expenses  above  those  necessary 
to  renew  worn-out  parts  in  the  way  in  which  they  were  originally 
built.  On  the  other  hand,  there  is  something  to  be  said  in  favor 
of  the  method  of  accounting  which  has  been  followed  in  this 
country.  If  all  renewals  beyond  replacements  in  kind  are 
charged  to  capital,  a  steady  increase  in  capitalization  and  rates 
necessarily  results.  In  this  manner  the  large  capital  of  some  of 
the  foreign  roads  has  been  produced.  Our  railroads,  on  the 
contrary,  have  preferred  to  keep  their  capital  low  by  taking 
advantage  of  good  years  to  make  extensive  replacements  and 
improvements,  charging  them  to  operating  expenses.  It  is  urged, 
on  the  one  hand,  that  since  the  revenue  with  which  to  pay  for 
this  replacement  came  from  operating  expenses  and  these 
revenues  were  contributed  by  the  public  in  the  form  of  rates,  the 
public  has  contributed  to  the  company  a  portion  of  its  capital, 
and,  therefore,  that  the  company  is  not  entitled  at  the  present 
time  to  any  return  to  it  by  the  public  in  rates  upon  such  capital ; 
but  it  should  be  remembered  that  the  public  had  it  in  its  power 
to  regulate  rates  and  to  prevent  such  return  of  capital  to  a  con- 
siderable extent,  and  that  it  did  not  do  so.  Further,  the  surplus 
might  have  been  distributed  to  stockholders.  The  result  of  this 
development  has  been  that  this  country  has  become  possessed  of 


47 

a  system  of  railroads  unequalled  by  those  in  any  other  country 
in  the  service  that  they  give,  and  capitalized  at  a  figure  lower 
than  in  any  other  country,  and  carrying  their  traffic  at  rates 
lower,  on  the  whole,  than  any  other  country.  The  history  of  the 
past,  therefore,  has  not  been  entirely  unfavorable  to  the  interests 
of  the  public.  With  more  stringent  regulation,  the  history  of  the 
future,  many  believe,  will  not  be  so  favorable. 

As  a  result  of  considering  the  controversy  between  the  original 
cost  method  and  the  cost  of  reproduction  method  many  dis- 
interested students  have  finally  come  to  the  same  conclusion, 
which  is  this:  Neither  method  of  ascertaining  value  is  in  all 
cases,  or  perhaps  in  any  case,  the  exclusive  basis.  Both  should  be 
considered,  if  ascertainable.  The  wisdom  of  the  decision  of  the 
Supreme  Court  in  the  case  of  Smythe  vs.  Ames,  so  many  times 
quoted,  will,  I  think,  become  more  apparent  the  more  carefully 
this  question  is  studied.  It  reads  as  follows : 

We  hold,  however,  that  the  basis  of  all  calculations  as  to  the 
reasonableness  of  rates  to  be  charged  by  a  corporation  maintain- 
ing a  highway  under  legislative  sanction  must  be  the  fair  value  of 
the  property  being  used  by  it  for  the  convenience  of  the  public. 
And  in  order  to  ascertain  that  value  the  original  cost  of  construc- 
tion, the  amount  expended  in  permanent  improvements,  the  amount 
and  market  value  of  its  bonds  and  stocks,  the  present  as  compared 
with  the  original  cost  of  construction,  the  probable  earning  capacity 
of  the  property  under  particular  rates  prescribed  by  statute,  and 
the  sum  required  to  meet  operating  expenses,  are  all  matters  for 
consideration  and  are  to  be  given  weight  as  may  be  just  and  right 
in  each  case.  We  do  not  say  that  there  may  not  be  other  matters 
to  be  regarded  in  estimating  the  value  of  the  property.  What  the 
company  is  entitled  to  ask  is  a  fair  return  upon  the  value  of  that 
which  it  employs  for  the  public  convenience. 

Furthermore,  many  will  thoroughly  approve  the  words  of 
your  own  eminent  jurist,  Justice  H.  M.  Wright,  who  makes  the 
following  remarks  with  reference  to  the  original  cost  method : 

Original  cost  is  urged  as  a  criterion  of  value  by  certain  econ- 
omists and  state  officials.  The  theory  is  that  the  return  in  money 
which  is  the  inducement  and  the  reward  for  serving  the  community 
with  water  or  gas,  or  other  service,  is  justly  to  be  determined  on 
the  basis  of  the  amount  of  sacrifice  on  the  part  of  the  investor, 
and  this  amount  of  sacrifice  is  summarily  identified  with  the  original 
investment  in  existing  property.  The  assumption  neglects  to  take 
account  of  the  fact  that  there  would  ordinarily  be  successive 
owners  of  the  property  or  of  shares  in  it,  and  at  different  purchase 
prices.  Furthermore,  the  test  proposed  applies  to  property  devoted 
to  the  public  use,  the  socialistic  basis  for  fixing  value,  while  the 
property  of  all  other  persons  in  the  community  is  valued  in  accord- 
ance with  the  non-socialistic  basis  of  our  economic  structure  with- 


48 

out  reference  to  its  cost.  Money,  the  measure  of  value,  changes  in 
purchasing  power  in  obedience  to  economic  laws.  .  .  .  Original  cost 
is  of  course  a  test  of  controlling  importance  in  the  case  of  newly 
constructed  or  acquired  property.  It  may  be  a  valuable  check  upon 
the  value  of  property  of  moderate  age;  but  generally  it  will  have 
no  significance  as  regards  property,  say  of  forty  or  fifty  years' 
elapsed  life. 

I  think  that  most  unprejudiced  students  after  considering 
these  matters,  will  be  apt  to  agree  with  Judge  Wright  and  to 
reach  substantially  the  following  conclusions : 

In  the  case  of  a  public  utility  constructed  today  and  under 
public  regulation  from  the  beginning,  the  investor  should  be 
satisfied  with  a  fair  return,  commensurate  with  the  risk  involved, 
upon  the  actual  investment.  If  rates  sufficiently  high  to  produce 
such  return  are  guaranteed  by  the  public  the  investor  must  take 
the  risk  that  the  investment  will  be  a  losing  proposition,  and  that 
when  rates  are  fixed  so  as  to  produce  a  maximum  return  that 
maximum  may  be  less  than  a  fair  return  upon  the  investment. 
What  a  fair  return  is  will  depend  upon  this  risk,  but  he  should 
be  guaranteed  that  the  public  will  not  interfere  with  the  imposi- 
tion of  rates  which,  if  they  can  be  collected,  will  produce  such 
fair  return. 

In  the  case  of  utilities  of  comparatively  recent  construction, 
and  especially  if  under  public  regulation  from  the  beginning,  the 
same  basis  would  hold.  In  the  case,  however,  of  utilities  which 
have  been  allowed  to  operate  for  many  years  without  public 
regulation,  a  new  start  should  now  be  made  and  a  valuation  fixed 
as  a  starting  point,  accounting  methods  and  the  issue  of  securi- 
ties to  be  subject  to  public  approval  in  the  future.  The  value 
to  be  fixed  as  a  new  starting  point  should  be,  as  the  courts  have 
decided,  not  less  than  the  fair  present  value  of  the  properties  and 
in  the  ascertainment  of  such  fair  present  value,  as  Judge  Wright 
so  wisely  says,  the  original  cost  will  have  no  significance.  Indeed, 
neither  original  cost  nor  reproduction  cost  will  be  the  sole  test, 
but  we  shall  come  back  to  the  words  of  wisdom,  so  often  quoted, 
in  the  case  of  Smythe  vs.  Ames. 

Another  of  the  much  discussed  points  regarding  valuation 
may  now  be  referred  to,  as  it  is  of  great  importance,  namely,  the 
question  whether  depreciation  should  be  deducted  from  the  value 
now,  whether  found  by  the  original  cost  method  or  the  cost  of 
reproduction  method. 


49 

When  an  industrial  plant  or  a  public  service  plant  is  put  into 
operation,  many  of  the  individual  units  immediately  begin  to 
depreciate  in  value  and  condition  on  account  of  use,  wear,  decay, 
and  perhaps  approaching  obsolescence.  The  time  will  come  when 
such  units  will  have  to  be  replaced.  How  shall  this  be  provided 
for?  At  first  sight  it  appears  that  the  proper  method  would  be 
to  set  aside  each  year  out  of  earnings,  the  total  amount  of  the 
accrued  depreciation  in  that  year,  and  to  carry  the  sums  so  set 
aside  in  a  depreciation  or  reserve  fund,  paying  out  of  this  fund 
each  year  for  the  renewals  in  kind  which  are  necessary.  This 
places  the  company  in  strong  financial  position  and  enables  it  to 
meet  renewals  when  due.  Such  a  fund,  however,  is  a  return  of 
capital  to  the  company  by  those  who  buy  its  product.  The  same 
result  might  be  accomplished  by  building  up  a  surplus,  but  in 
this  case  stockholders  might  demand  a  distribution  of  this  surplus, 
whereas  if  the  proper  amount  is  held  in  a  depreciation  fund 
stockholders  may  not  demand  that  this  be  distributed. 

Such  a  procedure  is  eminently  desirable,  and  generally  pos- 
sible, in  the  case  of  an  industrial  plant,  for  just  two  reasons: 
(1)  that  the  industrial  concern  can  charge  any  price  that  it 
pleases  for  its  product;  (2)  that  an  industrial  plant  frequently 
finds  itself  in  a  position  in  which  it  is  necessary  to  make  very 
extensive  renewals  in  a  single  year.  Let  us  consider  these  reasons. 

1.  An  industrial  plant  is  not  subject,  except  perhaps  in  ex- 
ceptional times  like  the  present,  to  any  public  regulation.    It  can 
charge  what  it  likes  for  its  product.     It  is  limited  only  by  com- 
petition with  other  concerns  making  similar  products,   and   it 
generally  and  properly  aims  to  make  the  prices  which  it  charges 
such  as  will  produce  a  volume  of  sales  that  will  result  in  the 
maximum  net  return.    Whether  it  makes  rails  or  razors,  or  drugs, 
or  soap,   or  furniture,  or  refined  oil,   or  any   other  industrial 
product,  it  is  not  limited  by  the  public  in  regard  to  the  prices 
which  it  can  exact.    It  may  earn  40,  50,  or  even  100  per  cent  of 
its  capital  stock  in  a  single  year. 

2.  An  industrial  plant  frequently  finds  it  necessary  to  make 
large  renewals  in  a  single  year.    Improvements  in  machinery  and 
methods  of  manufacture,  the  introduction  of  new  apparatus  and 
processes,  and  other  circumstances,  some  of  them  unforeseen  and 
unforeseeable,  may  at  some  time  render  it  necessary  to  entirely 


50 

reconstruct  the  plant  in  order  to  enable  it  to  do  business  econom- 
ically and  to  meet  competition.  When  such  expenditures  become 
necessary,  if  the  company  has  not  accumulated  a  surplus  or  a 
depreciation  fund  sufficient  for  the  purpose  it  may  find  itself  in 
a  serious  situation.  It  will  either  be  obliged  to  continue  its  busi- 
ness without  making  the  renewals  which  are  necessary  and  which 
will  result  in  economy,  or  it  must  get  new  capital  for  the  purpose. 
It  is,  therefore,  wise  for  it  to  accumulate  a  depreciation  fund.  It 
should  make  hay  while  the  sun  shines,  and  while  it  enjoys  a  good 
business  it  should  provide  for  the  inevitable  future. 

Now  when  such  a  depreciation  fund  has  been  accumulated, 
what  is  it  ?  Clearly  it  is  original  capital  which  has  been  returned 
to  the  company  by  those  who  have  bought  its  products  in  past 
years.  It  is  amortization  of  the  capital.  The  balance  sheet  shows 
this  clearly.  On  the  asset  side  stands  the  original  cost.  From  this 
is  deducted  the  depreciation,  so  that  the  cost  is  carried  at  a 
depreciated  value.  On  the  same  side  stands  the  depreciation 
fund,  which  should  be  equal  to  the  deducted  depreciation.  On 
the  liability  side  stands  the  original  capital.  When  any  renewal 
of  a  part  of  the  plant  is  necessary  the  situation  is  this:  the 
original  investment  in  that  part  of  the  plant  has  not  only  earned 
for  its  owners  a  fair  return  during  its  life,  but  the  original 
capital  investment  in  it  has  also  been  returned  to  the  owners  by 
the  public,  and  is  now  available  by  the  company  for  a  renewal  of 
that  element. 

A  public  service  corporation,  and  particularly  a  railroad, 
differs  radically  from  an  industrial  plant  in  regard  to  both  of 
the  elements  which  justify  the  accumulation  of  a  depreciation 
fund. 

In  the  first  place  a  railroad  company  is  not  justified  in  asking 
the  public  to  return  to  it  any  portion  of  its  original  capital.  It 
is  under  public  regulation.  Its  rates  are  subject  to  being  fixed 
by  a  public  commission,  and  if  they  were  not,  public  opinion 
would  exert  a  corresponding  pressure.  If  the  public,  through 
its  regulating  body,  requires  or  allows  the  company  to  accumulate 
a  depreciation  fund,  and  permits  it  to  charge  rates  sufficient  for 
the  purpose,  it  may  be  wise  in  certain  particular  cases  for  the 
company  to  set  aside  such  a  fund.  In  electric  light  plants,  gas 
plants,  to  some  extent  in  water  works,  where,  as  in  industrial 


51 

corporations,  large  renewals  may  become  necessary  in  a  single 
year,  it  may  be  desirable  to  accumulate  such  a  fund,  and  in  some 
instances  the  public  authorities  permit  it,  and  perhaps  require  it. 
A  railroad,  however,  is  essentially  different.  It  will  never 
need  renewal  as  a  whole,  or  in  any  large  part,  because  it  consists 
of  such  an  immense  number  of  separate  units.  It  will  presently 
be  shown,  also,  that  in  the  case  of  a  railroad  the  accumulation  of 
such  a  fund  is  neither  necessary  nor  desirable. 

What  should  a  railroad  company  be  allowed  to  obtain  from 
the  public  in  return  for  the  commodity  which  it  furnishes  ?  ( 1 ) 
It  should  be  enabled  to  earn  its  operating  expenses,  because  it  has 
to  pay  them  out  year  by  year,  or  perhaps  week  by  week.  (2)  It 
should  be  allowed  to  earn  its  taxes,  which  are  paid  to  the  public. 
(3)  It  should  be  allowed  to  earn  its  fixed  charges  or  the  interest 
on  its  fixed  capital  obligations,  because  if  it  does  not  it  may  be 
obliged  to  go  into  the  hands  of  a  receiver,  or  to  borrow  money 
to  pay  interest,  which  would  be  bad  financial  policy,  and  could 
only  be  done  at  high  rates  if  at  all.  (4)  It  must  be  allowed  to 
earn  enough  to  pay  for  renewals  as  they  become  necessary. 
Otherwise  the  property  will  run  down  and  become  less  efficient  as 
a  servant  of  the  public.  (5)  It  should  be  allowed  to  earn  a  fair 
return  to  its  owners  on  the  capital  stock.  These  then,  are  the 
earnings  which  a  railroad  should  be  allowed  to  make :  operating 
expenses,  taxes,  fixed  charges,  maintenance  and  necessary  re- 
newals, a  fair  return.  Should  it  also  be  allowed  or  required  to 
earn  the  amount  of  accrued  depreciation  and  to  carry  this  in  a 
depreciation  fund? 

A  little  consideration  will  show  that  this  is  neither  necessary 
nor  desirable,  for  the  reason  that  a  railroad  lacks  the  second 
element  which  makes  the  accumulation  of  such  a  fund  desirable 
in  the  case  of  an  industrial  corporation.  No  large  part  or  element 
of  a  railroad  will  require  renewal  in  any  one  year,  because  the 
multiplicity  of  its  parts  is  so  great.  Annually  accruing  deprecia- 
tion and  annual  expenses  for  renewals  tend  to  reach  a  condition 
of  equilibrium  in  which  one  of  these  is  equal  to  the  other.  By 
skillful  management  the  departure  from  this  condition  of  equili- 
brium may  be  made  very  small.  If  a  large  bridge  is  weak  and 
needs  renewal  there  are  various  methods  of  meeting  the  emerg- 
ency. The  bridge  may  be  strengthened,  or  temporarily  sup- 


52 

ported  by  placing  pile  bents  beneath  it  and  shortening  the  span. 
Many  bridges  needing  renewal  have  been  treated  in  this  way,  and 
carried  for  ten  or  fifteen  years  without  renewal.  If  a  large  struc- 
ture requires  renewal  this  year  the  renewal  of  a  corresponding 
number  of  smaller  structures  may  be  postponed. 

To  earn  anything  more  than  operating  expenses,  taxes,  fixed 
charges,  necessary  maintenance  and  renewals,  and  a  fair  return 
means  that  the  public  is  returning  to  the  company  its  capital. 
The  company  should  by  skilled  management  endeavor  to  make 
renewals  come  due  in  such  a  way  that  they  may  be  fairly  uniform 
from  year  to  year.  If  in  any  one  year  a  large  item  of  expense 
is  to  be  met  for  renewals  other  items  can  be  cut  down  or  post- 
poned by  temporary  measures  until  subsequent  years.  If  such 
renewals  cannot  be  met  from  current  earnings  the  company  may 
borrow  money  or  incur  a  floating  debt  for  the  purpose,  which 
is  retired  as  soon  as  possible  even  if  rates  have  to  be  temporarily 
somewhat  increased  in  order  to  do  so.  Such  a  plan  provides  for 
obsolescence.  A  new  structure  may  be  much  better  than  the  one 
which  it  replaces  but  it  seems  proper  that  future  customers  should 
bear  the  expense  involved  in  securing  the  better  facilities  rather 
than  to  have  the  expense  borne  by  the  customers  who  had  only 
enjoyed  the  benefit  of  the  inferior  facilities  previously  available. 
Such  a  plan  puts  the  burden  of  paying  upon  those  who  enjoy  the 
facilities  which  they  pay  for. 

Furthermore,  it  is  easy  to  see  that  in  the  case  of  a  railroad, 
with  its  great  number  and  diversity  of  units,  to  build  up  a 
depreciation  fund  would  not  only  be  undesirable  but  would 
result  in  a  useless  fund.  This  is  true  in  the  case  of  any  concern, 
whether  an  industrial  concern  or  a  public  service  corporation,  in 
which  the  multiplicity  of  units  is  such  that  renewals  in  time  come 
to  be  an  approximately  constant  expense. 

The  situation  is  best  illustrated  in  the  case  of  the  ties  of  a 
railroad,  because  ihcy  are  the  shortest-lived  element,  and  the 
illustration  is  easier  to  grasp.  Suppose  that  a  railroad  is  10,000 
miles  long,  with  25,000  ties  to  the  mile.  It  has  25,000,000  ties. 
If  these  cost  60  cents  apiece  they  are  represented  in  the  capital 
account  by  $15,000,000.  If  the  average  length  of  life  of  a  tie  is 
ten  years,  then,  inasmuch  as  ties  differ  and  are  not  all  of  the  same 
quality  when  put  into  the  railroad  and  inasmuch  as  the  wear 


53 

upon  them  differs  according  to  the  location  and  the  traffic,  they 
will,  even  if  all  are  put  in  at  the  same  time,  wear  out  at  different 
times.  Some  of  them  may  last  only  five  years,  others  may  last 
twelve  or  fifteen,  depending  upon  circumstances.  Ultimately, 
when  the  condition  of  equilibrium  is  reached,  there  would  be  an 
annually  accruing  depreciation  of  ties  of  one-tenth  of  the  capital 
represented,  or  $1,500,000 ;  and  during  each  year  about  one-tenth 
of  all  the  ties  will  be  renewed,  at  a  cost  of  $1,500,000.  The  con- 
dition of  equilibrium  is  reached  when  the  depreciation  of  the  ties 
is  between  40  and  50  per  cent  and  the  depreciated  value  between 
50  and  60  per  cent.  If  a  considerable  portion  of  the  railroad  is 
new  the  condition  of  equilibrium  will  not  have  been  reached.  Tie 
renewals  will  not  equal  annually  accruing  depreciation.  Assume 
the  depreciation  to  be  40  per  cent  and  the  depreciated  value  60 
per  cent.  In  this  case  the  depreciation  in  the  ties  will  be  40  per 
cent  of  $15,000,000  or  $6,000,000,  and  this  will  be  included  in  the 
total  depreciation  of  the  property.  During  the  following  year 
the  annual  accruing  depreciation  would  be  $1,500,000,  and  the  tie 
renewals  somewhat  less,  so  that  the  fund,  if  it  had  been  set  aside, 
would  be  increased  this  year.  The  condition  of  equilibrium  will 
be  reached  when  the  fund  reaches  45  per  cent  of  $15,000,000,  or 
$6,750,000.  After  that  time  in  any  one  year  what  is  paid  into 
the  fund  would  be  exactly  balanced  by  what  is  taken  out  of  it. 
The  fund  would  represent  capital  for  ties  which  has  been  returned 
to  the  company  by  the  public.  Of  what  use  is  it  to  accumulate 
this  fund  for  the  simple  purpose  of  having  it  ?  If  the  answer  is 
made,  let  the  fund  now  be  used  to  meet  cost  of  renewals  without 
adding  to  the  fund  out  of  earnings,  then,  if  this  is  done,  the  fund 
will  gradually  disappear.  But  what  would  be  the  justification 
for  such  a  procedure? 

At  this  point  another  consideration  comes  in.  In  an  industrial 
plant  the  concern  not  infrequently  starts  in  with  large  earnings. 
If  it  is  economically  constructed  and  supplies  a  commodity  that 
the  public  wants,  the  entire  field  is  at  once  immediately  opened 
to  it.  Earnings  may  be  large  from  the  beginning.  A  railroad 
company  is  radically  different.  It  is  generally  built  into  new 
country,  and  in  advance  of  a  market  for  its  product,  namely, 
transportation.  It  builds  its  line  into  territory  where  the  trans- 
portation facilities  have  been  insufficient,  and  where  the  business 


54 

must  be  developed.  At  the  beginning,  therefore,  its  earnings  may 
be  small,  until  the  country  becomes  settled  and  its  resources 
developed.  This  is  particularly  the  case  with  our  trans-conti- 
nental roads,  like  the  Canadian  Pacific,  Canadian  Northern,  and 
the  American  roads.  In  early  years  the  earnings  may  be  so  small 
as  to  produce  for  a  long  time  no  return  to  stockholders,  who  must 
have  faith  and  wait  for  the  development  of  the  country  before 
they  get  any  dividend.  In  some  instances  the  early  returns  may 
be  so  small  that  that  company  cannot  pay  its  fixed  charges,  and 
is  obliged  to  reorganize  according  to  a  plan  which  will  cut  down 
those  fixed  charges.  Such  has  been  the  experience  of  many 
American  railroads,  as  is  well  known.  Now  what  would  be  the 
use  of  requiring  a  company  under  such  circumstances,  in  the 
early  days,  to  set  aside  a  fund  to  provide  for  depreciation  of  ties, 
thereby  burdening  it  still  further.  Is  it  not  much  better  to  allow 
it  to  develop  its  traffic  as  fast  as  it  can,  meeting  necessary  tie 
renewals  as  they  become  necessary  from  year  to  year,  seeing  that 
ultimately  a  condition  of  equilibrium  will  be  reached,  without 
any  fund,  in  which  accruing  depreciation  will  be  equal  to  annual 
expenses  for  renewals? 

Every  other  element  of  a  railroad  is  in  essentially  the  same 
condition  that  has  been  described  with  reference  to  ties.  Bridges 
wear  out,  but  not  all  at  once,  as  there  are  great  numbers  of  them. 
The  same  is  true  of  rails,  buildings,  water  tanks,  and  every  other 
element  of  property  which  depreciates. 

The  above  seems  clearly  to  show  that  the  accumulation  of  a 
depreciation  reserve  in  the  case  of  a  railroad  is  neither  necessary 
nor  desirable.  As  a  matter  of  fact  it  is  not  required  in  the  United 
States,  except  in  the  case  of  equipment,  and  this  has  only  been 
required  within  a  very  few  years.  The  Interstate  Commerce 
Commission  in  all  the  years  of  its  existence,  from  1887,  did  not 
require  the  accumulation  of  a  depreciation  reserve,  until  a  few 
years  ago  for  equipment,  and  many  railroad  men  believe  that 
even  this  was  unnecessary,  because  even  equipment  does  not  wear 
out  all  at  once.  Furthermore,  it  may  be  claimed  that  with  refer- 
ence to  other  items  than  equipment  public  authorities  in  America 
do  not  permit  an  accumulation  of  a  depreciation  fund  for  the 
reason  that  although  it  is  not  prohibited,  the  public  authorities 
have  not  in  general  allowed  rates  to  be  high  enough  to  permit  of 


55 

such  a  fund  being  accumulated.  No  American  railroad  accumu- 
lates a  depreciation  fund,  so  far  as  I  am  aware,  for  anything 
except  equipment. 

If  the  public  authorities  permit  or  require  a  depreciation 
fund  to  be  accumulated,  and  it  is  so  accumulated  and,  therefore, 
represented  in  the  assets  and  in  the  physical  valuation,  then  it  is 
proper  to  deduct  depreciation  from  the  value  of  the  property  new, 
the  amount  so  deducted  depending  upon  the  accounting  regula- 
tions with  reference  to  the  accumulation  of  the  fund.  Here  is 
where  accounting  comes  in.  There  are  various  methods  of  esti- 
mating depreciation,  all  based  on  an  assumed  life  of  the  element 
of  the  property  to  be  depreciated.  If  the  ' t  straight  line ' '  method 
is  used,  that  is  to  say,  if  the  depreciation  is  supposed  to  be 
uniform  each  year,  and  the  fund  is  accumulated  on  this  basis,  it 
should  be  so  figured  in  the  valuation.  If  the  "sinking  fund" 
method  is  required,  then  this  method  should  be  figured  in  the 
valuation. 

The  above  consideration  clearly  demonstrates,  it  seems  to  me, 
the  following  propositions : 

1.  In  making  a  valuation  of  a  public  utility  property,  accrued 
depreciation  should  not  be  deducted  from  the  value  new,  unless 
a  depreciation  fund  has  been  accumulated,  in  which  case  the 
depreciation  for  the  elements  covered  by  said  fund,  computed  in 
the  same  manner  in  which  the  fund  has  been  computed,  should 
be  deducted.    The  fund  will  be  among  the  assets,  and  the  depre- 
ciation which  it  represents  should  properly  be  deducted  from  the 
value  new. 

2.  While  in  the  case  of  some  public  utility  properties,  like  gas 
and  electric  light  plants,  it  may  be  wise  in  the  public  interest  to 
permit,  encourage,  or  even  to  require  the  company  to  accumulate 
a  depreciation  fund,  permitting  it,  of  course,  to  charge  rates 
which  will  enable  it  to  do  so;  yet  in  the  case  of  a  railroad,  with 
its  great  multiplicity  of  elements,  the  accumulation  of  a  deprecia- 
tion fund  in  general  is  undesirable  and  unnecessary  in  the  public 
interest,  and  results  in  a  return  by  the  public  of  a  part  of  the 
capital  to  the  company,  to  constitute  a  useless  and  permanent 
fund. 

The  case  is  different  where  there  is  overdue  or  deferred  de- 
preciation; that  is  to  say,  where  renewals  which  were  necessary 


56 

to  maintain  the  property  in  good  operating  conditions  have  not 
been  made.  The  company  when  it  accepts  its  franchise,  accepts 
the  obligation  to  maintain  the  property  in  serviceable  working 
condition.  It  must  do  this  out  of  earnings,  without  increase  of 
capital  unless  improvements  are  made.  If  it  neglects  to  make 
necessary  renewals  in  kind,  excessive  or  overdue  depreciation 
results,  and  this  it  is  proper  to  deduct  from  the  value  new  in 
order  to  find  the  present  value,  but  only  this.  This  represents 
what  a  purchaser  would  have  to  pay  if  he  were  buying  the  prop- 
erty, in  addition  to  wrhat  he  pays  for  the  property  to  the  previous 
owners,  in  order  to  put  it  into  good  workable  condition;  and  he 
should,  therefore,  pay  that  much  less  than  what  would  be  its 
present  value  if  in  good  workable  condition. 

If  a  railroad  is  properly  maintained,  with  no  overdue  depre- 
ciation, it  is  just  as  valuable  an  operating  concern  as  if  it  were 
new.  The  owner  is  under  obligation  to  replace  worn  out  parts 
in  kind  when  they  become  worn  out,  without  increase  of  the 
capital.  Furthermore,  the  railroad  as  a  whole  never  wears  out  if 
properly  maintained.  Its  life  is  indefinite.  If  the  accrued  depre- 
ciation for  individual  items  is  added  together  it  results  in  an 
accrued  depreciation  for  the  entire  property.  We  have,  therefore, 
let  us  say,  ties  on  the  average  one-half  worn  out,  because  one- 
half  of  their  life  has  elapsed,  showing  a  present  value  of  50  per 
cent  of  the  value  known,  and  similarly  for  other  elements.  We 
have,  then,  the  entire  property  showing  a  depreciation  of  perhaps 
15  per  cent.  All  of  these  depreciations  for  individual  elements 
are  worked  out  by  one  method  or  another  from  life  tables,  that 
is  to  say,  from  tables  based  on  the  assumed  life  of  the  various 
elements;  and  by  adding  these  together  the  result  is  a  deprecia- 
tion in  the  value  of  the  entire  property  as  a  whole.  How  can 
there  be  a  depreciation  based  on  the  life  of  a  property  and  the 
portion  of  it  which  has  elapsed,  if  it  has  no  determinable  life, 
that  is,  if  its  life  is  indefinite?  The  property  as  a  whole,  if 
properly  maintained,  does  not  depreciate.  A  tie  on  a  railroad  may 
depreciate,  but  the  ties  of  a  railroad,  if  property  maintained, 
never  depreciate.  A  tie  has  a  life  of  ten  years,  therefore  if  it  is 
five  years  old  it  has  depreciated  50  per  cent.  The  ties  of  a  rail- 
road, if  properly  maintained,  have  an  indefinite  life.  Based  on 
this,  therefore,  they  have  no  depreciation  if  five  years  of  their  life 


57 

has  elapsed.  The  property  which  is  valued  is  a  railroad,  not  a 
part  of  a  railroad. 

Furthermore,  it  is  clear  that  no  depreciation  should  be  de- 
ducted from  the  value  new  of  a  properly  maintained  railroad 
property  when  it  is  considered  how  that  property  in  its  depre- 
ciated condition  could  be  reproduced.  The  only  way  to  repro- 
duce it  would  be  to  reproduce  it  new,  operate  it,  and  get  it  into 
its  present  condition,  in  which  case  the  cost  of  this  process  w7ould 
be  the  cost  of  reproducing  it  new.  It  could  not  be  reproduced 
with  depreciated  materials.  If  the  value  of  a  property  is  the  cost 
of  reproducing  it  in  its  present  condition,  then  the  value  of  a 
railroad  property  properly  maintained  is  the  cost  of  reproducing 
it  new. 

The  company  is  always  subjected  to  the  obligation  of  making 
replacements  in  kind  out  of  earnings  as  they  become  necessary. 
If  it  cannot  do  this  and  is  a  distinctly  losing  venture  then 
reorganization  may  be  necessary,  with  reduction  of  its  capital  and 
fixed  charges ;  but  so  long  as  it  has  the  credit  to  borrow  money 
to  make  necessary  renewals  w^hen  they  become  due  it  should  be 
allowed  to  do  so,  since  it  will  have  to  pay  the  interest  on  this 
borrowed  money  as  well  as  to  make  the  renewals. 

I  believe  that  opinion  is  beginning  to  change  with  reference 
to  the  propriety  and  fairness  of  deducting  depreciation  from 
value  new.  Members  of  the  Massachusetts  Railroad  Commission 
severely  criticized  several  years  ago  a  report  which  the  writer 
made  in  which  he  advocated  making  no  such  deduction,  and  it  is, 
therefore,  all  the  more  interesting  to  find  that  the  chairman  of 
that  Commission  has  recently  made  the  following  statement : 

In  the  matter  of  depreciation,  so  far  as  it  has  been  a  matter  of 
discussion  by  the  Public  Service  Commission  of  this  State,  in  the 
various  decisions  which  it  has  rendered,  it  has  come  before  us  in  a 
double  aspect.  The  problem  which  confronted  the  Commission  in 
the  first  instance  was  to  determine  just  what  recognition  should  be 
given  to  accrued  depreciation,  in  determining  the  fair  value  of  the 
property  upon  which  the  company  is  entitled,  under  the  law,  to  a 
fair  return.  The  Commission  was  faced  with  that  problem  shortly 
after  its  organization,  in  the  Middlesex  and  Boston  rate  case.  The 
Commission  in  that  case  began,  for  the  first  time  in  this  State,  to 
exercise  supervisory  rate-making  powers.  It  was  natural,  therefore, 
that  it  should  examine  the  precedents  in  Commission  and  court 
decisions,  throughout  the  rest  of  the  country,  in  determining  the 
basis  which  it  should  use  in  determining  fair  value  for  rate-making 
purposes. 


58 

Depreciating  Investment 

We  found  that  throughout  the  country  at  large,  the  theory  which 
had  received  recognition,  far  and  away  beyond  any  other  theory; 
that  had  almost  become  crystallized  into  a  legal  rule,  was  the  rule 
that  a  return  should  be  allowed  only  upon  the  value  of  the  property, 
less  depreciation.  That  is  to  say,  if  you  had  a  property  with  a 
value  new  of  $30,000,000  and  if  it  was  in  the  normal  service  con- 
dition of  75  per  cent,  the  company  would  be  entitled  to  a  return  on 
only  seven  millions  and  a  half,  although  it  might  have  ten  millions 
of  securities  outstanding,  which  were  issued  under  public  super- 
vision in  this  State. 

The  Commission  did  not  believe  that  rule  was  sound  or  just  to 
the  men  who  had  put  their  money  into  the  properties.  It  did  not 
believe,  further,  from  an  examination  of  the  public  utility  field, 
that  the  application  of  any  theory  of  that  kind  could  be  enforced 
without  risking  the  practical  bankruptcy  of  a  large  number  of  the 
street  railway  companies  in  this  State. 

The  consequence  was  that  the  Commission  adopted  the  theory 
that  if  this  money  was  honestly  invested  in  the  properties  in  the 
first  instance,  and  that  they  were  maintained  with  anything  like  a 
decent  degree  of  maintenance,  that  the  companies  and  the  investors 
were  not  to  be  penalized,  in  the  absence  of  mismanagement,  for  any 
depreciation  of  the  property  that  had  been  brought  about  in  the 
public  service,  unless  it  could  be  shown  that  the  company  had 
profited  from  that  situation,  rather  than  the  car-riding  public. 

The  study  of  this  subject,  like  the  study  of  most  subjects  that 
are  largely  of  an  economic  character,  is  interesting  as  a  study 
of  human  nature.  It  discloses  to  us  some  of  the  virtues  and  many 
of  the  weaknesses  and  prejudices  of  humanity.  If  we  are,  our- 
selves, unprejudiced  and  open  to  conviction  it  perhaps  makes  us 
more  tolerant  and  charitable  toward  those  who  differ  from  us  in 
opinion,  but  it  must  convince  us  of  the  truth  of  the  striking 
statement  of  Lecky,  who  says  in  one  place : 

Strange  veins  of  insanity  and  capacities  for  enthusiastic  folly 
sometimes  flaw  the  strongest  brains,  and  the  impetuous  ebullitions 
of  youth  which  impel  some  men  in  extravagances  of  vice"  impel 
other  natures  into  equally  wild  extravagances  of  thought. 

and  in  another  place : 

There  is  such  a  thing  as  an  honest  man  with  a  dishonest  mind. 
There  are  men  who  are  wholly  incapable  of  deliberate  willful  un- 
truthfulnes,  but  who  have  the  habit  of  quibbling  with  their  con- 
victions and  by  skillful  casuistry  persuading  themselves  that  what 
they  wish  is  right. 

At  all  events  it  should  make  us  more  careful  and  moderate 
in  forming  our  own  opinions  and  more  tolerant  of  differences  of 
opinion,  if  coming  from  men  whom  we  personally  respect,  whose 
motives  we  do  not  question,  and  who  express  their  criticisms  and 
differences  with  courtesy  and  kindness  rather  than  with  malignity. 


59 

Finally,  it  seems  to  the  speaker  that  there  is  one  portion  of 
the  decision  of  the  Supreme  Court  in  the  Knoxville  case  which 
has  not  been  quoted  or  regarded  so  extensively  as  it  deserves  to 
be.  It  indirectly  recognizes  the  fact  that  the  property  of  the 
public  service  corporation  is  private  property.  It  reads  as  follows : 

Our  social  system  rests  largely  upon  the  sanctity  of  private 
property,  and  that  State  or  community  which  seeks  to  invade  it 
will  soon  discover  the  error  in  the  disaster  which  follows.  The 
slight  gain  to  the  consumer,  which  he  would  obtain  from  a  reduc- 
tion in  the  rates  charged  by  public  service  corporations,  is  as 
nothing  compared  with  his  share  in  the  ruin  which  would  be  brought 
about  by  denying  to  private  property  its  just  reward,  thus  un- 
settling values  and  destroying  confidence. 


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